In recent years investors have had to cope with much larger price fluctuations than ever before. Moreover, the credit crisis has changed the way investors view the markets’ behaviour. At any rate, the basic concept of modern investment theory, i.e. that markets are efficient and any problems will resolve themselves, was shattered during the credit crisis. Many financial markets were disrupted and ceased to function. Another firm conviction of many investors that failed to survive the credit crisis was the ‘certainty’ that house prices in the US would continue to rise. At the same time, yields on the government bond of ‘safe’ countries (Germany, Netherlands, US) are now so low that investors are running an interest rate risk, the risk of interest rates rising (and bond prices consequently falling). In the US, yields on ten-year treasuries are at historically low levels.
This environment - that can continue for years to come - explains the popularity of Dividend Investing.
The Case for High Dividend Investing
So what specifically makes Dividend Investing attractive in this difficult environment? First of all, there is low economic growth and sharp price swings and this lower growth has become more uncertain and this situation is unlikely to disappear soon. Generally, dividend accounts for a larger part of the total return in such conditions than it does in times of above-average economic growth.
Another factor is the demographic situation. The average age of the population in the mature economies is rising and the working population is shrinking. The ageing of the population will also have a negative effect on economic growth in the decades ahead, not only in Japan but in the western economies as well. Another consequence is that more people are dependent on investment yields in the current environment of low yields.
High Dividend Investing for the Emerging Markets
When examining investment opportunities, it is impossible to ignore the emerging markets story and Dividend Investing is no different. While the big picture for the global economy has brightened, the fast-growing emerging economies are becoming increasingly important. The robust growth in the emerging world is relatively buoying up the global economy. Although emerging markets cannot maintain the same very high growth rates of recent years, they should continue to grow faster structurally than the more developed economies.
From a purely dividend yield perspective, investors can already choose from ample opportunities for dividends in Emerging Markets.
Indeed, the dividend yield on emerging market equities, currently around 2.7%, is now higher than some major developed markets such as the US (2.2% dividend yield) and Japan (2.2%), although Japan also has shown impressive dividend growth over the last 5 years. This year, emerging market companies will pay 35% of retained earnings as dividends, which is a third above 2000 levels.
Furthermore, a higher percentage of emerging market companies are paying dividends than in the developed world, with around 85% compared to 82% in the West. Currently, there are around 600 stocks in emerging markets that are sufficiently liquid for institutional investors which offer dividend yields of over 2%.
From a purely dividend yield perspective, Western investors could diversify into emerging markets where dividend growth is supported by low levels of company debt coupled and high profitability. Looking forward, we predict that dividend income will be more significant in overall emerging market equity returns as capital gains achieved over the last decade will be difficult to repeat.
So, in short, what are the major arguments underpinning the attraction of investing in emerging markets dividend stocks? Basically, they are best summarised as below:
1. Improved capital discipline and a better understanding of shareholders
Emerging market companies have become more investible as their commitment to dividends increases shareholder alignment and accountability.2. Less debt and growing cash flow
Emerging market companies have less debt than their counterparts in the developed world, and many are also amassing cash faster than they are paying out dividends. This underpins dividend sustainability and dividend growth potential.3. Government policy
Many listed emerging market companies are partly owned by their governments, and there is evidence here that in some cases the State is keen to access some of the cash held by these companies.
It is no secret that emerging market equities have been seen as attractive because of their strong capital growth potential, but increasingly the story for investing in this asset class has expanded to include dividend yield (growth). Therefore, it would be advisable for investors to look at the potential of dividends particularly those in emerging markets.
