Shopping for yield? Have you considered Asia Pacific ex Japan equity income?

Growth in emerging markets (EMs) has been elusive. For years, economists have forecast strong GDP growth, and investors have expected multiple rounds of earnings expansion supported by rising income levels, penetration of goods and services, and premiumisation. Yet the long-term growth of EM equity has barely surpassed that of developed markets.

Regarding the performance of EM equity, there are many reasons for the lack of consistency. One explanation is risk perception. EM equity is considered a high-risk asset class. Every now and then, EMs experience significant outflows triggered by global risk events such as trade frictions, COVID-19, inflation, or military conflict. These risk events cause risk-averse investors to rotate back to relatively lower-risk assets, disrupting the performance of EMs.

As many EM stock markets are still in the early stage of development and foreign ownership is high, there is often insufficient support from domestic investors when global money pulls out.

As global risk perception will likely remain elevated, we believe yield-generating assets will continue to be one of the lower-risk options for long-term investors in their asset allocation.

Looking towards Asia for income

Asia Pacific (APAC) ex Japan equity income stands out as a strategy that is potentially well suited to investors’ pursuit for yield and as an opportunity to diversify away from US equities, which are dominated by the ‘Magnificent Seven’.

Typically comprising companies generating strong and growing cashflows, we believe APAC equity income has various potential merits, combining the structural growth drivers of EMs with a notable dividend. These assets may be considered particularly attractive when US real bond yields are low, and cash, albeit being a high yield asset currently, doesn't provide the potential for growth. 

We see two potential diversification* benefits from APAC equity income. One, an opportunity to diversify away from the US and its concentration risks. Second, APAC combines both developed markets and EMs, with the index split roughly 20% to developed countries and 80% to EMs, according to the MSCI indices.

Historical data shows APAC ex Japan equity income (represented by the MSCI AC Asia Pacific ex Japan High Dividend Yield Index) consistently outperformed EM equity (represented by MSCI EM index) in the long run. Since the inception of MSCI EM Net Total Return Index in 2000, the annualised total net return from MSCI AC Asia Pacific ex Japan High Dividend was 9.1%, surpassing 7.6% from MSCI EM.

Over the same period since 2000, APAC equity income also outperformed US equities (represented by S&P 500) which delivered an annualised total return of 7.6%. However, in a similar fashion to EMs, APAC equity income has started to underperform the US since 2015, which was most notably driven by Fed rate hike cycles and a strong USD.  

Similar to EMs, APAC equity income have typically shown gains during periods of a weakening USD. Expectation of Fed rate cuts has clearly fuelled the growth of EM and APAC equity since end 2023.

Will the USD weaken? Based on existing macro data, there’s still uncertainty regarding whether and when the Fed will cut rate. Investors also debate over the magnitude of potential rate cuts.

We would argue that regardless of the US central bank’s decision on rates, APAC equity income could potentially stand to benefit in either scenario: ‘higher rates for longer’ could bolster investors’ pursuit for growing yield, while rate cuts could encourage fund flows back into EMs.

Moreover, there are several other positive trends that we believe could potentially support future performance. In addition to common themes that could benefit EMs, such as manufacturing reshoring, green investments, commodities upcycle, and technological innovation, the ongoing corporate governance reforms in several Asian markets could be positive to APAC equity income, as companies are encouraged to increase dividend payments and shareholder returns.

It's important to note that investing in countries where investment markets are considered less developed is generally riskier than in developed markets because they may not be as well regulated, may be more difficult to buy and sell, may have less reliable arrangements for the safekeeping of investments or may be more exposed to political and taxation uncertainties.

Nonetheless, we believe the theme of shopping for real yield in the structurally growing and diversified APAC region will remain intact over the long term. Furthermore, an active asset allocation approach to investing in APAC can be key to identifying companies with true competitive advantages that have potential to deliver higher income in the future.

*It should be noted that diversification is no guarantee against a loss in a declining market.