Asia investors seek volatility hedge in income investments
Bull markets are usually characterized by exuberance, but instead many in the region would prefer to play it safe
Bull markets are usually characterized by exuberance. Instead, many Asia-Pacific investors would prefer to play it safe and add income plays, as lofty valuations and geopolitical uncertainties cloud the extended rise in equities.
“Income investing has been popular with Asian and Hong Kong investors,” said Tai Hui, chief Asia market strategist at JP Morgan Asset Management. “Many investors are still concerned about market volatility as a result of the global financial crisis.”
Income investing targets high-yielding asset classes that deliver regular returns, such as fixed income instruments, dividend-paying equities and real estate investment trusts (REITs). Traditionally favored by conservative corners of the market dependent on steady cash flow, income investing has become a viable option for mainstream investors as well who are content to preserve their purchasing power and compound returns over the long-term.
Hong Kong investors have also signaled a weakened appetite for pure equity plays after the benchmark Hang Seng Index tumbled nearly 20% in the second-half of 2015. Average daily trading turnover in the city slumped 36.6% last year to HK$66.9 billion.
Investors who parked their cash in JP Morgan’s Asia-Pacific Income Fund, which is tilted about 60% to equity and 40% to fixed income, would have earned 6.1% a year on average over the past five years. Investing in a basket of regional equities would have actually performed on par during that time span. The Vanguard FTSE Pacific ETF, which tracks more than 2,000 stocks in major markets across Asia-Pacific, also generated an average annual return of 6.1% per year.
The Asia-Pacific Income Fund looks better on a risk-adjusted basis over the past five years, however, with a Sharpe ratio of 0.66 versus the Vanguard ETF’s 0.51, according to Morningstar data. Sharpe ratios measure an investment’s average return in relation to its volatility. A reading of 1.0 or higher is generally considered desirable for investors looking to avoid excess risk.
Other Asian-themed income funds have also been solidly in the black. Schroders’ Asian Asset Income Fund has gained a cumulative 41.7% in five years and Aberdeen’s Asian Income Fund has increased 55.5% over that span, according to fact sheet data through January in which calculations reinvest net income. Both funds include a mixture of equity and fixed income positions.
Income investments in Asia-Pacific may appeal to value-focused investors who are looking to diversify from US stocks which have enjoyed a prolonged bull market. The S&P 500 Index currently trades around 25 times earnings, a level not seen since the global financial crisis. Investors considering Asia-Pacific not only stand to benefit from diversification but could also enjoy a potential wave of future earnings growth, according to JP Morgan’s Hui.
“With the possible peaking of the US dollar in the next 12 to 18 months, Asian and emerging market equities can benefit,” he said. “Moreover, there are a greater variety of companies that provide an attractive income in these regions relative to the US.”
Income investors can be encouraged that dividend dollars have been on the rise in the Asia-Pacific. One out of every five dollars of the US$1.15 trillion paid out globally in dividends last year originated from a company based in either Asia or Australia, according to the Henderson Global Dividend Index. These companies’ contributions climbed a combined 5.7% from 2015 while dividend payouts in the rest of the world dipped 1.3%.
Relatively higher bond yields are another factor drawing income-hunters to Asia-Pacific. 10-year government bond yields tallied 2.43% in Singapore, 3.47% in China, 5.1% in the Philippines and 7.38% in Indonesia through March 15, according to Asian Development Bank data.
Meanwhile in Europe, the United Kingdom’s 10-year gilt offered a 1.21% yield, Germany’s 10-year bund yielded just 0.41% and Switzerland’s 10-year bond traded at a -0.08% yield through March 15, according to Bloomberg data.
The United States’ benchmark 10-year government bonds stands out as a bright spot, trading around a 2.50% yield through March 15 after the Federal Reserve raised its key lending rate 25 basis points to a target range of 0.75% to 1% and signaled that it will likely authorize additional rate hikes this year and next.
Further monetary tightening around the world looks to complicate a market environment already challenged by high valuations and rising inflation. Investors should resist the urge to sit on the sidelines, however, according to Michael Fredericks, head of income investing for BlackRock’s multi-asset strategies group.
“There is also risk in the seemingly safe ‘run to cash’ scenario – in the form of opportunity lost,” Fredericks wrote in a report last December. “The Holy Grail for income investors today is selectivity and an active, eyes-wide-open approach to managing opportunities and risk.”