Equity income is a powerful, if underappreciated, theme within emerging markets.
The case for investing in emerging markets is generally underpinned by economic data underscoring the growth credentials of these regions.
However, with increasing sophistication and liquidity, markets have become capable of supporting a more nuanced range of investment strategies, other than growth itself.
Among these, equity income is one that appeals to the many investors for whom this is a core approach in developed markets.
Looking at the performance of emerging markets on a price-return and total-return basis over the short term, it is clear that price movement and resultant capital gain or loss will heavily influence investors’ returns. However, these are highly dependent on market timing.
On a longer-term basis, returns in emerging markets are driven by the compounding power of reinvesting dividends.
Not only are dividends a key element of long-term returns but, as elsewhere, dividend-paying companies tend to outperform non-dividend-paying companies.
Dividends are paid out of cashflow, cannot be mis-stated and are a powerful signal about management’s confidence in their company’s prospects.
The requirement to pay a dividend imposes stronger capital discipline on management and is closely associated with higher-quality companies.
The number of dividend-paying companies in emerging markets has climbed from 78 at the start of 2001 to 281 at the end of 2013. Behind this headline lies a growth across sectors and regions, which provides a diverse universe from which investors can select stocks to build a balanced portfolio.
A stock that typifies this is MTN, a South African telecoms company. The firm has a 4.5 per cent yield, has grown consistently over the past five years and is funded by income that is up by approximately 80 per cent since 2009.
The share price has responded, more than doubling from its pre-crisis peak, and is up more than 160 per cent since 2010.
Equally, Philippine utility company Aboitiz Power has a 4 per cent yield, growing by more than 50 per cent over five years, and the share price is up 440 per cent since 2010.
The number and types of companies that are paying dividends is rising, and investors are increasingly finding the potential of a regular income stream attractive, given the low-yield environment we are operating in.
While through to April 2014 emerging markets had a lacklustre couple of years compared with developed markets, the cash flow from an equity income strategy offered investors an ongoing utility, providing a cushion for performance on a total-return basis.
Furthermore, by focusing on a key element of long-term total return, it obviated the need for investors to monitor short-term market movements.
For these reasons, investors are increasingly embracing an income-orientated approach when investing in emerging markets, and we expect this trend to continue.
Will Ballard is senior fund manager, quant equities, at Aviva Investors
