Time for Asia to finally emerge from the West's shadow?

While global economic news flow from the West continues to dictate the fortunes of Asian markets in the short-term, could the region be poised to step out from the West's shadow on a long-term view? In this fund update Michael Kerley, manager of the Henderson Horizon Fund – Asian Dividend Income Fund, considers why Asian markets – particularly China – appear uniquely placed to emerge from the global recession in a position of strength.

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After an extremely volatile start to the year, global markets have experienced something of a revival in the last six weeks or so, largely as a result of improving economic data coming from the US and the general notion that global policy initiatives to combat the downturn are starting to gain traction.

It should be remembered that stabilisation is not the same as recovery, therefore the recent bounce should not be over-played. We expect markets to remain volatile throughout the year as further economic news flow – both positive and negative – is fully digested.

Moreover, following their recent equity market strength, the likelihood is that we can expect a period of consolidation as investors look to take some profits. The point to consider is that now that stability has been reached, where next for Asian markets? The answer lies in the fact that the recent downturn has not been one of Asia's making.

Asian equity markets have been pegged back by the underperformance from the rest of the world, even though below the surface the differences between the two regions are quite pronounced. The financials crisis almost drained the lifeblood from Western economies whereas in Asia it has merely been a flesh wound.

While governments in the West have spent billions in order to support a financial sector close to ruination, Asian banks have needed nothing like the same support. Asian banks have not had to contend with the liquidity problems associated with their US or European counterparts and (with the exception of Korean and Australian banks) have been successful in maintaining a far more frugal loan to deposit ratio.

The scale of Chinese policy measures continues to impress
Government policy measures aimed at stimulating Asian markets should be able to exert a stronger impact on the real economy, because although there is always a lag between policy implementation and the subsequent impact on the economy, capital is still being absorbed at a far quicker rate than in the West. China remains the most notable example of this. This year the Chinese government has announced a series of measures aimed at sustaining domestic demand and stimulating growth, including:

• Aggressive cuts in interest rates
• Scrapping of controls on bank lending
• Various measures to encourage home-buying
• A RMB 4 trillion stimulus package (covering public housing, infrastructure projects, health and education) over a two-year period

The fiscal stimulus is expected to rebalance the sources of economic growth, moving away from investment and export-led areas and more towards domestic consumption-driven growth. The chief beneficiaries of this would include property developers and industrial sectors, steel producers and power generation companies. The long-term success of these policies will ultimately dictate whether China can emerge from this downturn fully de-coupled from the US.

Portfolio positioning
Consequently, the positioning of the Henderson Horizon Fund – Asian Dividend Income Fund remains focused on domestic Asia and away from export sectors that have fallen prey to global weakness. In terms of country allocation, we are overweight on China, Hong Kong and Singapore.

We maintain the view that China is the engine of growth in the region. However, whereas in 2008 we could not justify the valuations of many Chinese companies, the recent downturn has meant that we now see significant investment opportunities to purchase companies set to participate in China's long-term structural growth story.

In terms of sector allocation, we are overweight financials, telecommunications services and industrials. We think that many banks across the region (China, Thailand, etc.) have been oversold and are currently priced at discounts to fair value given their profitability and outlook. Bank of China for example, is China's third largest bank and one of the fund's largest holdings. China Mobile is continuing to gain market share and recently announced the acquisition of 12% of Taiwanese mobile operator Far EasTone. Telecoms are looking particularly attractive at present, due to their strong cashflow generation, potential for yield growth and cheap valuations. The industrial sector is the key beneficiary of government spending across the region and the portfolio is exposed to this theme through investments in Chinese infrastructure related companies Lonking Holdings, China Communication Construction and Jiangsu Expressway.

Property companies are our top pick in Hong Kong as the combination of cheap asset prices and a low interest rate environment has increased affordability. In Singapore, we have been focusing our attention on companies able to demonstrate sustainable cashflow generation and set to benefit from increased infrastructure spending. Key holdings include DBS, ST Engineering, SPH, Venture, Ascendas REIT and Keppel.

Why income remains the primary focus for investors

Asia's 60-year-old-plus population is expected to double by 2040, which means that income-focused funds, are now back in fashion. For investors looking for a stable income-generating strategy in this current market environment, dividends from strong Asian companies within financials, industrials and telecommunication services are likely to remain resilient. However, investing for income doesn't have to mean your portfolio is restricted in terms of the areas in which it can invest.

When it comes to investing for value and income, we view total return to be more important than dividend yield alone. While 50% of the portfolio consists of core stocks that are currently paying out high dividends the other 50% consists of stocks with the potential to grow their cash flows and dividends. Our strategy is therefore to provide an attractive, stable dividend yield, without giving up the potential for long-term capital growth. Investors can still participate in the structural and long-term growth story in Asia but with lower risk and volatility compared to investing in a purely growth-focused fund. It is also worth noting that over the last 30 years dividends have been the main driver of total returns from equities in the region (see chart).

Dividends as a percentage of total return

While the likelihood of weaker dividends is greater in some of the more cyclical areas of the market, they look more secure in those areas exposed to domestic consumption and investment. In addition, traditionally high yielding sectors – such as financials – offer more sustainable yields in Asia than they do in other parts of the world.

Taking a more long-term view, dividend yields from Asia continue to be sustainable, because companies have become firmly entrenched in the dividend growth mindset. We are no longer seeing the levels of corporate excess that we saw in Asian markets a decade or so ago. Companies have learned their lessons and have emerged with greater capital discipline, lower leverage and major improvements in corporate governance and shareholder awareness.

The long-term outlook for the region

In the short-term, the outlook for Asia remains very much dependent on the depth and longevity of the global recession, as markets are still heavily reliant on external growth. If the economic recovery can continue, the region should benefit from an improved sentiment and hopefully export demand can pick up if the global recession proves to be relatively short-lived. In the long-term, Asian markets are positioned to grow considerably compared to their western counterparts.

The real challenge for governments – particularly China – over the next five to ten years will be to see how far they can move from an export-led economy to a more domestic-focused economy, based on consumption and investment strength. This will be no easy feat but if policy measures are successful in mobilising savings effectively and converting them into assets, we could see a significant change in emphasis from those investors who recognise that a region with long-term growth prospects combined with genuine economic stability has a great deal to offer.

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