In a note on completing ten years of managing the First State Dividend Advantage Fund, Lau said he remains focused on investing in high quality companies that are trading at attractive valuations and which offer reasonable dividend yields.
First State launched the dividend yield product in November 2004 to provide investors a combination of income and growth in a low interest rate environment.
“Back in 2004 it was easy to find good quality companies which provided dividend yields of 5-7%. Today, it is difficult to find reasonable ones giving yields of 3-4% which is a significant challenge for the fund going forward.”
In terms of future fund positioning, Lau said the firm is seeing plenty of ideas developing in the Indian market, which currently has about 23% weighting in the portfolio.
“It is much more difficult to find good ideas in China or South Korea, although the opening up of the A-share market to foreign investors should provide more choice in China and improve the quality of Chinese companies over the next decade.”
Just not dividend yield
He stressed dividend yield is not the sole factor for arriving at an investment decision, but cash flow matters, too.
“The example of Australian REIT GPT shows how such a focus can be dangerous. The company was a favourite of investors looking for income because of its attractive dividend. However, it went bust during the global financial crisis because of its debt levels.
“A number of REITs in Singapore faced similar problems and had to raise cash from existing shareholders to survive.”
Chinese banks with yields that are higher than price-to-earning ratios do not offer attractive investment, as the downside is huge given the high debt levels in the economy.
“I am reminded of the Royal Bank of Scotland which traded on a single-digit PE ratio before going bust in 2008.
“We believe it’s vital to focus on cash flow as well as dividend yield.”
He cited the example of Taiwanese technology company Taiwan Semiconductor. His team was attracted by the company’s free cash flow yield of above 6%, which ultimately supported share price growth. The yield is now 3% because the share price has doubled since the investment, he said.
It is also necessary to take into account differences between countries in the region.
“Over the years I have learned not to take a mechanical approach to yield, but rather a nuanced one.”
He observed large pay-out ratios are common in Hong Kong and Australia, while a dividend culture is less developed in other markets such as India, Japan and South Korea.
Taiwan Semiconductor, Hong Kong’s Cheung Kong Holdings, India’s Dabur and China’s ENN Energy are the holdings that the manager has held for most of the decade.
According to September-end details, Cheung Kong Holdings (3.9% weighting), Taiwan Semiconductor (3.4%] and Dabur India (3.4%) are also the top three holdings.
“They have all performed strongly and we are happy to continue holding them.”
As of September-end, the fund’s highest country positions were in Taiwan (12.7%), South Korea (11.8%), Hong Kong (11.7%) and Singapore (11.3%).
Top sector allocations are in financials (27.5%), consumer staples (21.1%) and information technology (14.5%).
Ideas missed
Lau shared a few investment ideas that were missed during the decade.
“Our negative view on the Australian dollar and economy over the last decade meant that we did not hold any Australian banks, missing out on substantial upside in share prices.”
Similarly, the fund did not invest in internet companies such as Baidu.
“These decisions often stemmed from our conservative investment style. However, we believe our philosophy of focusing on preserving capital is a vital component in providing good returns for our investors over the long term.”
He added that First State intends to widen its investment universe to markets such as Bangladesh, Burma, Cambodia, Sri Lanka and Vietnam, which are likely to become more prominent over the next ten years.
