Investment trusts: Asia for income

Asia has long been considered one of the go-to parts of the world for growth investors, but there is an increasingly compelling case for income investors to consider the region. Here we explore some of the key reasons why, with a specific look at the Schroder Oriental Income Fund.

A key starting point for any income investor will often be starting yield. This is defined as the income return an investor should expect from an investment in the first year. In the case of Asian equities, that starting point is currently an attractive one. As the chart below illustrates, the current yield on the MSCI AC Pacific ex Japan Index is over 3% standing close to its highest level since the global financial crisis. That makes Asia second only to the UK in terms of starting yield among the major global investment regions. From several perspectives, however, Asia has an income differentiator which UK investors may wish to consider.

Source: Thomson Datastream, Schroders, as at 31 March 2023.Countries shown are for illustrative purposes only and should not be viewed as a recommendation to buy or sell.

Diversification

Firstly, Asia represents a good income diversifier. As investors, we are often warned about having too many eggs in one basket, and by embracing dividends from another region such as Asia, we introduce some welcome diversification to our portfolio. This is particularly the case when you consider the dividend concentration risk that exists in the UK stock market. Half of the income from UK stocks comes from just eight companies – if any of those businesses were to cut their dividend or pass on it altogether, that can leave a significant dent in a portfolio’s income generating capacity. By contrast, 39 stocks account for half of Asia’s dividend yield, which makes it a much more diverse, and potentially more resilient, source of income as it means investors are less reliant on any single company than they are in the UK.

Source: FactSet, MSCI, Schroders, Total dividends paid calculated using the dividend yield and market value, as at March 2023. Countries shown are for illustrative purposes only and should not be viewed as a recommendation to buy or sell.

Positive growth dynamics

Secondly, Asia from an economic standpoint benefits from a more positive growth outlook than the UK and indeed many other parts of the world. The attractive starting yield on Asian equities is accompanied by higher levels of growth and payout ratios that aren’t stretched versus history. The payout ratio is the proportion of earnings paid as dividends. Meanwhile, levels of corporate gearing also tend to be lower in Asia, meaning financial risk is lower.

Improving shareholder returns

Thirdly, attitudes towards shareholder returns have seen some improvement across Asia, as have standards of corporate governance in many areas. Asia is of course, made up of a large number of different economies, each with its own unique dynamics and characteristics. Not all economies have made the same amount of progress on shareholder returns and corporate governance, but it is interesting to note that there appears to be a correlation between the two. The chart below illustrates this, showing the positive relationship between dividend pay-out ratios and corporate governance standards across a range of Asian countries.

Source: CLSA 2021, ACGA, Facstet, MSCI, Updated April 2023. Countries and regions shown are for illustrative purposes only and should not be viewed as a recommendation to buy or sell.

In a region that has seen its fair share of corporate governance downfalls in recent years, a focus on shareholder returns through a decent dividend pay-out ratio suggests that management teams have a disciplined approach to capital allocation decision-making, which in turn, reduces the likelihood they will waste money on value-destroying investments. Dividends can only be paid out of real earnings and cash flows. As a result, Asian companies that pay a good proportion of their earnings to shareholders as dividends are frequently also those with high corporate governance standards.

For many reasons, therefore the case for investing for income in Asia is persuasive and has the potential to deliver attractive long-term total returns, with a balance between growth and income that could be enticing to all sorts of investors. And, with nearly 60% of Asian companies now yielding 3% or more, it is a fertile hunting ground for income stock pickers.

Introducing the Schroder Oriental Income Fund

Income investors may need look no further than the Schroder Oriental Income Fund for exposure to the Asia dividend income story. It is the largest and most liquid investment trust in the AIC Asia Pacific Equity Income sector and offers UK income seekers an effective way of diversifying their dividend sources away from the domestic market.

Since its inception in July 2005, the trust has typically outperformed the MSCI All Country Pacific excluding Japan Index by a clear margin, particularly over longer time periods. It has also significantly outpaced the FTSE 100 Index and, importantly, it has grown its dividend every year since launch and is named as one of the AIC’s “next generation of dividend heroes” (defined as investment trusts that that have increased their dividends for 10 or more years in a row but fewer than 20).

The fund is managed by Richard Sennitt, who has been successfully managing Asian income strategies since 2006. He is supported by Abbas Barkhordar, and Schroders’ broader team of 39 Asian equity analysts based across the region. A bottom up fundamental approach sees Richard favour better managed companies with solid balance sheets, attractively valued earnings streams and appealing dividend prospects. Currently, that means a focus towards financials, information technology and real estate businesses, while from a geographical perspective, there is a clear bias towards the countries that score well in the dividend pay-out ratio and corporate governance chart above, such as Australia, Singapore and Taiwan.

Conclusion

A strong structural growth backdrop, high starting yields and improving shareholder returns make this an interesting time for UK investors to be considering Asia for additional equity income diversification. When coupled with a time-tested, disciplined investment process and Schroders’ historic investment success in the region, we believe the Schroders Oriental Income Fund should represent a simple, liquid and attractive way for investors to access the compelling Asian income opportunity.

Source: Schroders, Association of Investment Companies to 31/08/2022 (latest financial year end)
Past performance is not a guide to the future

Key risks that are specific to the company

Emerging markets risk: Emerging markets, and especially frontier markets, generally carry greater political, legal, counterparty and operational risk.

Currency risk: The company can be exposed to different currencies. Changes in foreign exchange rates could create losses.

Concentration risk: The company may be concentrated in a limited number of geographical regions, industry sectors, markets and/or individual positions. This may result in large changes in the value of the company, both up or down, which may adversely impact the performance of the company.

Gearing risk: The company may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so.

Counterparty risk: Investments such as warrants, participation certificates, guaranteed bonds, etc. will expose the company to the risk of the issuer of these instruments defaulting on paying the capital back to the company.

Distribution risk: As a result of fees being charged to capital, the distributable income of the company may be higher but there is the potential that performance or capital value may be eroded.

Important information

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Issued by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registration No 4191730 England. Authorised and regulated by the Financial Conduct Authority.

Important information

This communication is marketing material. The views and opinions contained herein are those of the named author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy.

The data has been sourced by Schroders and should be independently verified before further publication or use. No responsibility can be accepted for error of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.

Past Performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall.

Any sectors, securities, regions or countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.

The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors.

Issued by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.