Banca&Mercati

Investors are starved for yield. Developed market cash rates are close to zero and core government bond yields are almost at multi-decade lows, so global equities are an increasingly obvious choice for income investors. Anyway equity income investing is moving east: the amount of dividends paid by Asian companies should surpass that paid in Europe over the next decade

Investors are starved for yield. The combination of aggressive central bank policy and a flight to safety has helped push down cash rates and core government bond yields to exceptionally low levels. Even after the 16% rally in global equities from summer low core government bond yields have hardly moved. Cash rates in developed markets are negligible. They are higher in Emerging Markets but are forecast to come down. Core government bond yields are close to their lowest levels in over 50 years. Investors who want to stretch for yield will have to take on considerable default risk, currency risk or equity risk.
While many fixed income yields are touching or close to all time lows, global equity dividend yields are above long-term averages. We expect a global equity investor to collect a dividend yield of 3% this year. Close to the highest level in the last 20 years and also higher than core government bond yields (Fig. 1).

Fig. 1: Global-DY-vs-US-Govt-10Yr (Source: MSCI, Datastream)

Still despite these attractive yields investors remain reluctant to buy equities. An obvious issue is volatility. Investors have been put off by the volatility of equities. In the last 20 years investors have lost a maximum of 10% in a single year owning US government bonds or 27% in US junk bonds (Fig. 2). While these losses are not small they are dwarfed by the biggest annual decline in global equities – 42% (in 2008). The second biggest annual decline in equities was 19%. Investors reaching for yield in the equity market have to be prepared to endure the risk of a capital loss.
Equity yields may now be higher than bonds, but so is their risk of a capital loss.

Fig.2: Worst Year since 1990 – Total Return, % – (Source: Datastream)

The income investor is moving East 

So global equities are an increasingly obvious, if volatile, option for income investors. The traditional home for income investing has been the UK and Continental Europe. This is where a greater proportion of income funds still operate. In trying to attract this capital, companies have tended to payout a larger proportion of their profits in dividends. Almost half the total return from UK equities over the last 20 years has come from dividends. Income has made up more than a third of total returns for the rest of Europe. By comparison in the US, where dividends are traditionally less important, income has provided less than 30% of total equity returns.

Fig. 3: Proportion of Global Dividends Paid - Pan-Europe = UK + Europe ex UK. Pan-Asia = Asia ex Japan + Japan (Source: MSCI, Citi Investment Research and Analysis)

It is interesting to note that while the proportion of returns from income has varied by region, the total equity return has largely been the same, at around 8%, over the last 20 years. While many investors would rather the certainty that dividends provide, in the long run, it makes little difference to total returns.
While the historical home of income investing has been in Europe, it may now be moving east. In the mid 1990s Pan-European companies paid more than 40% of global dividends. Pan-Asian companies (includes companies listed in Asia ex-Japan and Japan) paid 15%. Since then the proportion of global dividends paid by European companies has steadily come down while it has gone up for Asia (Fig. 3). European companies paid $262bn in dividends in 2011. This is down from almost $300bn in 2007. Asian companies paid $156bn in 2011 (Fig. 4).

Fig. 4: $bn of Global Dividends Paid - Pan-Europe = UK + Europe ex UK. Pan-Asia = Asia ex Japan + Japan (Source: MSCI, Citi Investment Research and Analysis)

We expect these figures to converge further and eventually cross-over over the next decade. A reason why Asia is now paying a larger proportion of global dividends than in the past is because of the growing size of the Asian economy and equity market. There are more IPOs in Asia than elsewhere and almost all companies pay dividends. However, there are a number of other factors driving income investing east.
Financial theory suggests fast growing companies should reinvest earnings. But in Asia ex-Japan, the region with the fastest GDP growth in the world, companies continue to pay large dividends. Markus Rosgen, our Asian strategist, notes that this is partly because of the large proportion of family ownership in Asia ex-Japan. He notes the easiest way to keep harmonious relationships among the family is to payout decent dividends.
Second, dividends in tough times ensure loyalty amongst income investors. We believe the family ownership structure was a reason why the DPS draw down in Asia during the crisis of the late-1990s was “only” 20%. DPS fell by even less in Australia which also suffered from the crisis. This was the biggest annual drawdown in Asian dividends. The banking and sovereign crisis in Europe, which on many measures has been less severe than the Asian crisis, has resulted in DPS falling by 25-30%. Given low current leverage in the Asian corporate sector, we expect dividends will continue to remain relatively stable even as economic growth slows. The steadiness of Asian dividends, especially when compared to Europe and the US, should help build important loyalty amongst income investors.
Kenji Abe, our Japanese strategist, suggests a third reason why income investing is moving east, is because of increasing foreign ownership in Japan. He suggests that rising foreign ownership is a reason why dividends are rising in his market. Japanese companies began to increase dividends in the early 2000s, just after foreign ownership of Japanese equities surpassed 20%. Dividend hungry foreign investors now own more than a quarter of Japanese equities. To attract more foreign capital, Kenji believes Japanese companies will be tempted to raise dividends further.
All this means that global income funds should be spending more time looking for opportunities in Asia. Similarly, those investors disillusioned by the big dividend cuts in Europe and the US recently will appreciate more stable income stream available in Asia. We believe the factors we highlight above, in addition to stronger equity market growth, would mean Asian dividends will eventually surpass European (and US) dividends sometime over the next decade.

Robert Buckland
Mert Genc
Beata Manthey
Hasan Tevfik