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Every week, Kyle Caldwell and guests take a look at how the biggest stories and emerging trends could affect your investments, with practical tips and ideas to help you navigate your way through. Join the conversation, tell us what you want us to talk about or send us a question to OTM@ii.co.uk. Visit www.ii.co.uk for more investment insight and ideas.
Hello, and welcome to on the money, a weekly look how to get the best out of your savings and investments. In this episode, we're gonna be explaining the trends of companies in the Asia Pacific region becoming more dividend friendly over the past decades. However, for resale investors, it's arguably an overlooked trend with the Asia Pacific region generally views as more of a growth play. Joining me to discuss this topic is Isaac Thong, full manager of the Aberdeen Asian Income Fund, which is an investment trust. So, Isaac, to start off, could you explain how over the past decade, the landscape has broadened in terms of the opportunity set for investing in Asia Pacific companies that are paying a dividend?
Kyle Caldwell:So I've read the dividends now accounts for more than 50% of the total returns in the region. Do you have figures that show how that compares with a decade ago?
Isaac Thong:Yeah. To address your question, we are currently finding substantial opportunity for income in Asia. Asian companies are much better placed than ever before to pay and grow dividends on a sustainable basis. Free cash flow generation and debt levels are at their best historically, and we are finding many opportunities to invest in high quality dividend franchises in Asia. When you talk to corporates, many companies are realizing the benefits of having strong dividend policy and how that really sets them up optimally in the long run.
Isaac Thong:This is true of companies in China, India, in Thailand, in Korea, and many more. When you look at our investment universe, and we define that by companies that pay a cash dividend and have dividend yields of above 1%, that number a decade ago stood at 570 companies. Today, that number stands at 740, a 30% increase. And if we are gonna be even more strict than that and we raise that dividend yield threshold to 4%, we have 330 companies today versus a hundred and ninety ten years ago or a 70% increase. And when it comes to returns in terms of return contribution, dividends actually accounted for 59% of total returns in Asia over the last decade.
Isaac Thong:And if you look at the decade before that, dividends accounted for 51% of total returns. So, you know, we could say that total return contribution from dividends in Asia has actually increased over time.
Kyle Caldwell:And could you next talk about the investment trust's approach? So the focus is on looking for quality income. So how do you define that?
Isaac Thong:So our investment strategy is grounded on the fact that Asia is the heart of global growth. Asia has and will continue to drive over half of global GDP growth, and what's not so talked about is this economic growth has also translated over time to strong total shareholder returns. However, we believe that Asia's growth story should be pursued with a balanced approach, and that balance to us is achieved through quality income. So we like to use this analogy of driving a car down a highway. Right?
Isaac Thong:So imagine you're you're driving a car down the highway. The trouble is, unlike the highways here, the road is winding, and your car can only go fast because it's an Asian car. It's a it's a BYD. And, you know, you wanna be very sure that your car has a good set of brakes, you know, a functioning airbag, and great GPS navigation system so that you get home as quickly and as safely as possible. So that is essentially what our strategy in the trust seeks to deliver.
Isaac Thong:Right? And you know what? The the market already agrees with this. So like I mentioned, dividends account for over half of total returns in Asia. However, the market doesn't tell you why.
Isaac Thong:So if if you put that question on us, the short answer is we believe that Asia's growth comes along with a wider range of outcomes and should be unlocked with that quality income approach. That wider range of outcomes is a product of political and geopolitical uncertainties as well as corporate immaturity among Asian companies. Right? So we we seek to pull in that range of outcomes by ensuring companies have strong dividend policies. Cash dividend policies prevent management from making what we think are suboptimal capital allocation decisions and hence leading to better corporate governance.
Isaac Thong:When looking at stocks, you know, how do we wanna do this? When looking at stocks, we we want to invest in quality dividend franchises over the long run. Now what are quality dividend franchises? Well, to us, companies should exhibit three attributes. The first would be companies we wanna invest in are are fundamentally good businesses, and that they would they can achieve high and sustainable returns on equity over and above their cost of equity through the cycle.
Isaac Thong:Right? And these types of companies should also have strong, reliable free cash flow generation, and we, in effect, followed these cash flows towards strong dividend policy. So the three factors we look at kind of feed on each other, and the net outcome of that is a dividend franchise. So after identifying these dividend franchises, which in practice is more difficult because they're they're no perfect company, But after we we've identified these, what we wanna do is to invest across a range of dividend yields to capture the opportunity set in Asia across a range of companies at different stages of their corporate life cycles to achieve that overall balance.
Kyle Caldwell:And how does the opportunity set in Asia compare with The UK? So it's widely known that in The UK, dividends are very concentrated with the top 15 companies contribute into the majority of overall dividends in a given year. In Asia, is there a wider spread of companies contributing towards overall dividend growth?
Isaac Thong:The short answer is yes. Give let me give you some numbers. Right? So Asia offers a broader range of opportunities in income compared to The UK. Today, we have and we talked about that investable universe.
Isaac Thong:Right? Companies that pay a dividend, and the dividend yield is above 1%. If we apply that metric to Asia, we have 740 companies today, and this compares with just 350 in The UK if we apply the same metrics. In Asia, you essentially get more than twice the number of opportunities across a wider range of sectors. Hence, you not only get income opportunities, but you also have the benefit of diversification in portfolios.
Kyle Caldwell:And how does dividend growth and the overall dividend yields of the Asian market compare with The UK?
Isaac Thong:That's a good follow on. Let's be honest. When compared to Asia, The UK actually has superior levels of payout ratio and yields. Right? The average payout ratio over the last three years in The UK was 55%, and the current dividend yield or rather the forward dividend yield on a one year basis in The UK stands at 3.6%, and this compares to Asia's 40% payout ratio and dividend yield of 2.6.
Isaac Thong:Right? So you get better absolute opportunities in The UK. However, where The UK falls short is once again that breadth of income opportunities, which leads to diversification opportunities in Asia and really dividend growth. So if you look at the dividend per share growth in in The UK, this is expected to grow at 4%. Right?
Isaac Thong:But while Asia's dividend per share growth should grow at 10%.
Kyle Caldwell:You mentioned payout ratios. So a payout ratio is a metric of a company's earnings distributed to shareholders as dividends. Isaac, as part of your process, do you look for a certain percentage for a payout ratio for the company? And could you talk through how you strike the right balance between capital growth and income?
Isaac Thong:Right. So it really depends on the type of company we're looking at. Right? If you look at payout ratios, it's really influenced by the amount of growth that a company has. So imagine if a company can grow at a very high rate and at a very high returns, you know, that growth has high returns, then we call that quality growth.
Isaac Thong:And the more quality growth you have, the less dividends you should pay out because you wanna redeploy those earnings in into the business to drive really strong quality growth. But that said, as mentioned, for what we wanna do in the trust, after we identify dividend franchises, we want to invest across a range of dividend yields. This is essential to capture the opportunities in Asia across a range of companies at different stages of their corporate life cycle to achieve that balance in the portfolio. So, essentially, we are quite agnostic between dividends and earnings growth and view things on a total returns basis, which tends to be the sum of the two, earnings growth plus dividend yield. However, we also want to unlock Asia's potential with a balanced approach.
Isaac Thong:So to this extent, we do not want to have the whole trust being invested in high growing low yielders nor the opposite. The end outcome for us is a portfolio that is high quality and value conscious.
Kyle Caldwell:You mentioned earlier that the overall dividend yields for Asia Pacific is lower than UK. I think you said it's 2.6%. However, for the investment trust, you will have a yield much higher than that. It was announced earlier this year that Aberdeen Asian Income Fund will adopt an enhanced dividend policy. So under this policy, the annual dividend payments to shareholders will be worth 6.25 percent of its average net asset value.
Kyle Caldwell:So what does this translate into at the moment in terms of the dividend yields for the investment trust? And could you explain how that enhanced dividend is being funded? Is it being paid entirely through the income generated by the underlying holdings, or are you using other measures to fund that dividend?
Isaac Thong:Right. Let's let's talk about how we get there. So the underlying portfolio yield of the trust is 4.5%. So that's the average of all the the equities we hold for the trust. And through dividend enhancement trades, we increase this by another 2%.
Isaac Thong:This gets us to our 6.25% dividend commitment, which started this year, by the way. The discount that the trust trades at takes the effective yield to a rather attractive 7%. We enhance dividends by deploying a small portion of the portfolio into select stocks around their dividend ex dates. We only do this for stocks we currently hold for the trust and that we understand well. Therefore, the dividend is paid through income and and not through capital.
Kyle Caldwell:And could you highlight some stock examples that are in the investment trust that the investment trust has held for a long time that have produced both consistent dividend increases and also delivered strong capital growth as well.
Isaac Thong:Sure. Dividend franchises are held throughout the trust, like I previously mentioned. One example of a long term holding is TSMC. So Taiwan Semiconductor has produced consistent dividend increases alongside growth in earnings and therefore capital. So that's that's probably the the biggest example.
Isaac Thong:Another one is Infosys. It is a capital light Indian IT services company where free cash flow generation has been very strong, and it has also grown earnings at 9% over time. High quality banks in growth markets such as Indonesia and India promise to do the same. So we are long term holders of many of these dividend franchises.
Kyle Caldwell:And in terms of country weightings, which countries do you have the most exposure to overall in the investment trust?
Isaac Thong:So in terms of countries, we look at it as pools of income. Right? So there are natural pools of income out there, which are countries that have high quality companies with structural growth and that payout healthy amount of dividends. So that includes countries like Taiwan, Indonesia, and to an extent, Thailand. And then on the flip side, you have countries which are what we like to call consistent income countries.
Isaac Thong:These tend to be located in developed Asia. So they are high quality companies there as well, but these companies' earning stream tends to be more predictable and defensive. Right? Consistent. And this is also a feature of the portfolio, countries like Singapore and Australia.
Isaac Thong:And then we have countries that are more cyclical when it comes to income. So in these countries, we we have to look harder. They include China, India, and South Korea. But China and India are large deep market, so we can still find many quality dividend franchises here as well.
Kyle Caldwell:You mentioned TSMC, which is your biggest stock position in the investment trust. It's also a very big part of the MSCI all country Asia Pacific ex Japan index, but you actually have a bit more than the index in the stock. Why do you have such a big position in that one company?
Isaac Thong:Right. To us, TSMC is the highest quality company in Asia. It is also, like you say, 10% of the benchmark and deservedly so. Nobody really can do what TSMC does globally. It has close to 90% market share of leading edge chip fabrication, and its closest competitors, Intel and Samsung Foundry, are falling further and further behind.
Isaac Thong:AI demand is a significant driver of TSMC's revenues, and given its unrivaled position at the leading edge, TSMC should be able to grow both quickly and profitably over the years to come. TSMC is also one of the few companies in Asia that have a progressive dividend policy, meaning that it seeks to grow dividends evenly and stably over time, much like our investment trust. And amid current geopolitical uncertainty, TSMC is also building production capacity in The US, in Japan, as well as in Germany. So it is quickly becoming a globally diversified company of the future.
Kyle Caldwell:You've highlighted opportunities within the Asia Pacific region and how for income seeking investors, there's now a broader opportunity set. Could you talk us through the risks of investing in this part of the world? Of course, there's always some sort of macroeconomic risk in the news headlines. At the moment, it seems to be US tariffs. So how do you navigate macroeconomic risks?
Isaac Thong:Right. So like you mentioned, US tariffs are front row center right now. And as you can see from recent announcements, things remain in flux and subject to change, so rather unpredictable. Others uncertainties in Asia include politics and geopolitics, wider range of outcomes that I mentioned, coupled with the fact that companies are relatively young and immature corporate governance wise. So we acknowledge all these risks in Asia and really seek to mitigate them at a portfolio at both a portfolio level and at a company level.
Isaac Thong:So at a portfolio level, we hold conservative country active positions to minimize macro factor risk. And at a company level, we ensure that the companies we hold are sufficiently diversified and have contingency plans. For example, amid the ongoing US tariff uncertainties, we do hold Chinese consumer companies, which are, in our view, domestic champions. Their businesses are very domestic facing, and they have minimal exposure to The US in terms of exports.
Kyle Caldwell:That's all we have time for. My thanks to Isaac, and thank you for listening to this episode of On the Money. If you enjoyed it, please follow the show in your podcast app and do tell a friend about it. If you get a chance, leave us a review or a rating in your podcast app too. We'd love to hear from you.
Kyle Caldwell:You can get in touch by emailing otm@ii.co.uk. In the meantime, you can find more information and practical pointers on how to get the most out of your investments on the Interactive Investor website, which is ii.co.uk, and I'll see you next week.