Yu Zhang, manager of the Matthews Asia ex Japan Dividend Fund, on how the maturing dividend culture in Asia is creating an unrivalled environment for active stockpickers
WELCOME
Matthews Asia ex Japan Dividend Fund Manager Yu Zhang explains how he seeks to generate returns from an attractive dividend yield as well as from capital appreciation by investing in a mix of stable dividend payers and slightly more cyclical, faster-growth dividends stocks. Zhang explains why his investment process is driven from the bottom-up and focuses on underlying company fundamentals which help him to construct a high conviction portfolio of ideas that has successfully delivered attractive total returns for investors since the Fund’s inception.
Asia’s dividend landscape has evolved significantly over the past five years. Today it boasts a dividend pool of well over $240bn, encroaching on Europe and the U.S. at $317bn and $399bn respectively*. And while dividend yields in Asia have grown to be on a par with Europe and the U.S., dividend growth in Asia is almost double what it is in the West, offering a much faster growth rate of underlying dividends without changing dividend payout ratios.
THE INTERVIEW
Asia’s dividend payouts signal a lot about the capital management of companies as a whole
Yu Zhang, Fund Manager
“Many constituents of the MSCI Asia ex Japan Index offer healthy yields alongside growth, and over 100 companies in the index offer yields of more than 4% a year alongside future earnings per share above 10%,” notes Yu Zhang, Portfolio Manager at Matthews Asia. “We believe this is partly due to the ownership structure of many companies in Asia, which in contrast to Western companies consists mainly of family owners.” Often the original founder/family is still the majority shareholder of companies in Asia and dividends are a significant source of income and cashflow. In comparison, the dividend culture in the U.S. is often more nuanced, Zhang explains. “ Growth companies in the U.S. do not talk much about paying dividends. Often, the mere mention of dividend payments raises concerns that a stock could be de-rated and perceived to be ex-growth,” Zhang says. “But Asia does not have those concerns. It is home to some of the fastest growing companies globally as well as those ranked the highest in terms of dividend growth.” It is an ability to home in on such companies that Zhang believes can offer investors an uncorrelated source of income that is difficult to replicate in other regions. His Fund, the Matthews Asia ex Japan Dividend Fund, was launched in November 2015 to do just that. The investment philosophy is to invest primarily in companies that exhibit attractive dividend yields across the Asia ex Japan region. Importantly, he looks for those stocks which have the potential to grow those dividends over the long term. In addition, Zhang uses a company’s dividend process to analyse the underlying health of a company as well as its long-term prospects.
Often what a company chooses to do with its earnings explains a lot about capital allocation and management within the business as a whole, according to Zhang. A company paying a consistent and regular dividend to shareholders, for example, doesn’t have the flexibility for management to deviate from the core business model and invest excess free cashflow in non-core areas. This helps to reign in management to ensure they are focused only on their core competencies. In addition to looking at a stock’s dividend payout policy, Zhang notes it is important to understand the Asia earnings cycle before investing in a high-yielding stock. He explains: “We tend to think of our portfolio as a mixture of dividend growth stocks together with stable, high-yielding companies. But the earnings potential for high dividend-yielding stocks hold up much better than cyclical dividend growth companies in specific cycles. Therefore, as well as using dividend policy as a way to find investable stocks from the bottom-up, we also position our portfolio in slight anticipation of the market to ensure we incorporate a macro focus into the investment process. “For example, if we believe the market is likely to chase growth at any cost, we may tilt the portfolio toward stable, higher yielding stocks. “On the other hand, if we feel the market is in risk-averse mode, and people are chasing high-yielding stocks as a sort of ‘safe haven’, we are likely to find better opportunities in the growth companies.”
Though Zhang runs a fairly concentrated portfolio of circa 50-80 stocks, a number of portfolio tilts have been evidenced over the past year as concerns about trade between the U.S. and China have intensified. In addition, he has added to his positions in a number of high growth companies that he believes have been aggressively de-rated following concerns regarding the regulation of the Chinese and Hong Kong investment markets. “These are both examples of sentiment impacting market sell-offs rather than stocks experiencing any real change in their underlying fundamentals. “Whilst market sentiment has impacted some Chinese high growth stocks negatively over the past year, we have seen their valuations come down to a reasonable level whilst the dividend outlook has remained intact. They have proved to be key buying opportunities for us.” The Matthews Asia ex Japan Dividend Fund is benchmarked against the MSCI All Country Asia ex Japan Index, yet Zhang’s investment strategy is unconstrained in its nature. He points to the Fund’s exposure to frontier markets as an example of this; it includes a circa 11% exposure to Vietnam. Frontier exposure has proved useful for Zhang over the past year as a way to offset wider macro concerns regarding China. “People have been worried about trade tensions between China and the U.S. for over a year, but a market like Vietnam is actually extremely well positioned to benefit from any prolonged negotiations,” he says. “Vietnam has a growing, young population whilst the wage policy is much lower than in China. As a result, a lot of manufacturing companies are increasingly setting up in the region, providing a range of new employment opportunities and the potential for wage increases too. “Separately, there is also a very viable story around the rising level of consumption in Vietnam, with many companies delivering very healthy double-digit growth on the underlying dividends. This allows us to not only get paid via dividends each year, but the conducive conditions in the domestic market also help these companies to grow the underlying cash earnings in a very strong manner.”
Macro focus
Dividend annual growth rate (2007-2017)†
“Dividends in Asia have always been a large part of a company’s total return,” he explains. “But dividends also play an important role in helping to define a company’s underlying business model, the strength of its earnings and can provide insight into its corporate governance practices. These qualitative factors help us to narrow our focus down to a smaller subset of the broader Asian universe and assist us in identifying the best stocks for our portfolio.”
Benchmark unconstrained
*2018 dividends by index members as of April 2018; Europe (Bloomberg European 500 Index), Asia Pacific (MSCI AC Asia ex Japan Index), U.S. (S&P 500 Index). **10 Year Compound Annual Growth Rate of Dividends Paid by Constituents of MSCI AC Asia ex Japan by Country. Time period: 31/12/2006-31/12/2017. †Source: FactSet Research Systems, Inc. Data as of 22/03/2018 Past performance is no guarantee of future results. Indexes are unmanaged and it is not possible to invest directly in an index.
Source: Matthews Asia, FactSet Research Systems, Inc. As at 30 November 2018
Matthews Asia ex Japan Dividend Fund
Top country allocations
Source: Matthews Asia; Factset Research Systems. As at 30 November 2018.
FUND SNAPSHOT
The Matthews Asia ex Japan Dividend Fund is an all-cap strategy that pursues long-term total return through a balance of dividend growth and dividend yield. The fund, which has been managed by Yu Zhang since inception, focuses on a company’s willingness and its ability to pay dividends as well as grow those dividends over the long term. The strategy has held the fund management team in good stead, providing a cumulative return of 47.33% – ahead of its MSCI All Country Asia ex Japan benchmark. From an income return perspective, the fund has continued to outperform the index significantly, delivering a 14.6% return over three years.
Market cap exposure
Source: Matthews Asia; FactSet Research Systems. As at 30 November 2018.
Past performance is no guarantee of future results. Returns are calculated with a holdings-based methodology using software supplied by FactSet Research Systems, Inc. Income Return and Capital Return are for positions only and exclude fees and expense accruals. Returns will not equate to the standard, published performance for the Fund. The characteristics shown may not be representative of the Fund’s current or future investments. Indexes are unmanaged and it is not possible to invest directly in an index. Please refer to the disclosures for index definitions. Source: FactSet Research Systems. 30 November 2015 to 30 September 2018.
Top sector allocations
Matthews Asia ex Japan Dividend Fund vs MSCI AC Asia ex Japan Index Return Breakout
MACRO Q&A
We aim to identify those companies where the strength of the business model is likely to help them overcome near-term headwinds
We have gone through quite a few different cycles over the past few years and overall it has been a fairly challenging and volatile two or three years for Asia’s equity markets. Looking back, Asian companies really struggled in 2015-2016 in terms of delivering any sort of earnings growth, although this did turn around in 2016-2017. Last year, we saw an increasing number of external-related risk factors such as geopolitical trade issues, rising interest rates and high energy prices. All of these have been headwinds for Asian equities. At a portfolio level, we have ‘tilted’ the portfolio at different points of the cycle in order to manage these challenges. Whilst in 2015-2016 we saw opportunities in dividend growth names (which paid off in 2017 when the top contributors were in cyclical and high growth businesses), 2018 was a very challenging and quick-changing environment and Asian markets were in a very different place. As such, at the beginning of 2018 we began to pull back our exposure to cyclical dividend growth companies and reduced quite aggressively our holdings in the IT and financial services sectors. Instead, we added to stable utilities, telecoms and asset-heavy infrastructure businesses. This defensive stance helped pull up performance for the strategy overall in 2018.
What key macro challenges have impacted the Matthews Asia ex Japan Dividend Fund over the past year?
Those sorts of headlines mostly affect investor sentiment, which drives short-term market performance. The challenging part for us is to make a call on whether a business actually has structural strength behind its core business model, or whether the wider macro concerns have impacted the underlying business. If sentiment becomes an overwhelming driver for the share price in either direction, we try to use it as an opportunity rather than a reason to avoid specific sectors. We aim to identify those companies where we believe the strength of the business model is likely to help them overcome near-term headwinds. If a company can prove it can overcome weak sentiment, the actual earnings delivery is usually much better. I would not describe market sentiment as a friend, but it can provide the long term-minded investor with a window of opportunity.
Is it possible for a fund manager to avoid the negative headlines associated with wider macro challenges, such as China/US trade wars?
Our dividend strategy remains predominantly a growth strategy. Yet we tackle growth from a slightly different angle compared with pure growth products. Whilst others will be looking for earnings-per-share growth, we are more focused on dividend-per-share growth. This means that volatility plays a slightly different role in our portfolio. Although we do not specifically manage downside volatility, for example, the fact we focus squarely only on companies able to generate sustainable free cash flow, alongside the fact that dividend-paying companies in Asia tend to be conservative in terms of how they manage their balance sheet with low financial leverage, means a lot of the companies we invest in have a large net cash position.
Dividends: How Asia compares to Europe and the U.S.
How do you manage volatility within the fund?
Standard deviation of returns by market cap
We believe this is a good position to be in when the market goes through a volatile period. In addition, if some of those companies pay a significant portion of their earnings in dividends, the dividend yield tends to become a buffer in terms of holding up the stock’s valuation during periods of a drawdown. That has tended to produce a slightly lower level of volatility for the portfolio.
How is the portfolio split between smaller and larger companies?
The strategy is an all-cap portfolio, albeit with a heavy dose of mid- and small-cap exposure. Mid and small caps account for close to 70% of the overall portfolio, and nearly 35% of that exposure is in small caps. Now, many investors believe small-cap companies are much more volatile and tend to be focused on growth rather than income. In reality, small-cap companies in Asia are often family-owned and rely on dividends for a stable and consistent income. Therefore we view the small-cap sector in Asia as a way to access very fast-growing companies that at the same time have the ability to deliver a rising dividend. The Fund can be owned as a part of an investor’s core strategy for their Asia exposure, as it offers a set of growth opportunities in Asia. But at the same time, it potentially allows investors to get paid as the underlying dividend holdings deliver on that growth. Meanwhile, compared to a purely aggressive growth portfolio, the income-producing holdings within our Matthews Asia ex Japan Dividend strategy have been less volatile when compared with the broader market.
How does the Fund fit into a wider income strategy?
Source: Brown Brothers Harriman (Luxembourg) S.C.A., Bloomberg, 30 November 2015 to 30 September 2018.
*2018 dividends by index members as of April 2018; Europe (Bloomberg European 500 Index), Asia Pacific (MSCI AC Asia ex Japan Index), U.S. (S&P 500 Index). **Trailing Dividend yield estimates for 2018 as of October 31, 2018 based on FactSet aggregates. ***Compound annual growth rate (CAGR) based on index constituents of Europe (Bloomberg European 500 Index), Asia ex Japan (MSCI AC Asia ex Japan Index), U.S. (S&P 500 Index) as of 12/31/02, excluding those that are no longer in existence as of calendar year 2017.
CONTACT US
To learn more about Matthews Asia or how the Matthews Asia ex Japan Fund can compliment portfoilios, please visit global.matthewsasia.com or contact us directly Neil Steedman Head of UK and European Business Development +44 203 728 2667 neil.steedman@matthewsasia.com
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For Institutional/Professional Investors Only. Data as of 30 November 2018, unless otherwise noted. The MSCI All Country Asia ex Japan Small Cap Index is a free float–adjusted market capitalization–weighted small cap index of the stock markets of China, Hong Kong, India, Indonesia, Malaysia,Philippines, Singapore, South Korea, Taiwan and Thailand. The Bloomberg European 500 Index is a free float capitalization-weighted index of the 500 most highly capitalized European companies. The S&P 500 Index includes 500 leading companies in leading industries of the U.S. economy, capturing 75% coverage of U.S. equities. Indexes are unmanaged and it is not possible to invest directly in an index. The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Such materials do not necessarily reflect the opinion of Matthews Asia. Matthews Asia and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information. The views and information discussed herein are as of the date of publication, are subject to change and may not reflect current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Past performance is no guarantee of future results. No public offering or advertising of investment services or securities is intended to have taken effect through the provision of these materials. This is not intended for distribution or use in any jurisdiction in which such distribution, publication, issue or use is not lawful. The current prospectus, Key Investor Information Document or other offering documents (“Offering Documents”) can be obtained by visiting global.matthewsasia.com. Please read the Offering Documents carefully before investing as they explain the risks associated with investing in international and emerging markets. Matthews Asia is the brand for Matthews International Capital Management, LLC and its direct and indirect subsidiaries. Matthews International Capital Management, LLC is the Investment Manager to the Matthews Asia Funds, and is a U.S.-based investment adviser registered with the U.S. Securities and Exchange Commission who has not represented and will not represent that it is otherwise registered with any other regulator or regulatory body. In the UK, this document is only made available to professional clients and eligible counterparties as defined by the Financial Conduct Authority (“FCA”). Under no circumstances should this document be forwarded to anyone in the UK who is not a professional client or eligible counterparty as defined by the FCA. Issued in the UK by Matthews Global Investors (UK) Limited, which is authorised and regulated by the FCA, FRN 667893.
Risk Considerations The value of an investment in the Fund can go down as well as up and possible loss of principal is a risk of investing. Investments in international and emerging market securities may involve risks such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. The Fund invests in holdings denominated in foreign currencies, and is exposed to the risk that the value of the foreign currency will increase or decrease. The Fund invests primarily in equity securities, which may result in increased volatility. There is no guarantee that the Fund or the companies in its portfolio will pay or continue to pay dividends. These and other risks associated with investing in the Fund can be found in the Prospectus.
