Why should you look at exotic markets for income?

Henderson International Income Trust fund manager, Ben Lofthouse, examines why investors searching for income should look beyond UK equities and start to acquire a taste for more exotic markets

Most UK investors automatically look to UK companies for equity income as the UK equity market has on average traditionally offered a high dividend yield and UK companies have a deeply-embedded dividend culture. The march of globalisation, however, means that companies are increasingly operating across boundaries and the same is true of investor capital.

It makes sense, therefore, to view overseas companies as another source of income to complement the strong income and growth opportunities offered by UK equities. Companies with exposure to those regions with faster economic growth are expected to increase their dividends more rapidly than those companies facing more pedestrian growth rates.”

Lower growth

A combination of one off external shocks, in the form of the Japanese earthquake and Middle East unrest, and fiscal concerns in the US and Europe have resulted in forecasts for GDP being reduced recently. Although the consensus of economists’ forecasts is for a still healthy 3% global growth, equity markets have fallen to reflect a lower growth environment, especially in Europe.

Whilst dividend yields on equities were attractive before this fall, they are even more so now and investors with a global perspective currently have a wealth of opportunities to invest in a wide variety of sectors and geographies.

The financial crisis resulted in a number of companies cutting dividends, which had been increased to levels that were, with the benefit of hindsight, unsustainable. Now that phase has passed the majority of companies are increasing or at least maintaining their dividends. As shown in the graph (below), the number of companies cutting dividends has reduced significantly to levels seen before the crisis, and we are generally finding that those that are still paying dividends have passed a stern test such that their payments should be sustainable.

Although GDP forecasts have been reduced in recent months global growth is still forecast to be healthy and this is largely due to the growth in the BRIC and emerging markets. Investors often equate higher levels of economic growth with higher equity market valuations and often lower dividend yields. In the current environment this is not necessarily the case.

The table below shows the forecast 2012 growth rates for a number of economies and the forecast dividend yields for their equity markets. Everyone knows that China and Brazil are growing faster than Germany and the US, but it is not as widely known that they have similar, if not higher, dividend yields. In general dividend growth is driven by corporate earnings growth, which in turn is driven by economic growth; therefore these dividends should also be growing at a market level.

Dividend yields and GDP growth

_{Source: GDP Bloomberg consensus forecasts for 2012 as at 09/09/2011; Dividend Yield Societie General/Datastream 18/08/11}

Dividend decisions

It is difficult to give a simple answer to the question of what drives companies to pay more dividends in one country than another; dividend decisions can be driven by dominant shareholders (founders and states wanting income), mature industries with low capex requirements, and tax environments, to list just some of the reasons.

As a result it is the job of the investor to look at each company on a case by case basis to determine dividend sustainability, and at Henderson Global Investors we benefit by having numerous regional portfolio managers to share this job.