The eternal demand for yield among investors helps to explain why Henderson Far East Income is trading on a premium, even though its own manager Mike Kerley admitted performance “hasn’t been great”.
The trust is down by 11.77 per cent this year, compared with a fall of 0.78 per cent from its IT Asia Pacific Income sector and a gain of 12.43 per cent from the MSCI AC Asia ex Japan index. It trails behind both measures over the longer term as well.
Performance of trust vs sector and index in 2020
Source: FE Analytics
Kerley blamed this underperformance on his value approach and focus on companies with a growing cash flow, which has seen him miss out on the healthcare and internet stocks that have benefited from the coronavirus and whose valuations have “gone to the moon”.
However, the manager (pictured) said that while these sectors should remain well supported by short- and long-term trends, their valuations could well be called into question as other growth alternatives emerge.
To illustrate his point, he compared the recent performance of China Railway Construction, which he owns for exposure to the fixed-asset investment cycle in China, and food delivery platform Meituan Dianping.
“The share price [of China Railway Construction] has come down and the earnings have come down,” he said.
“But if you look at the scale, it is quite telling. From its peak, the share price came down from $8 to $5, but earnings (per share) have actually only come down by $1.65 to $1.59.
“So, yes earnings have come lower, but the share price has come down a whole lot more. If I told you now that China Construction is on 2.6x forward earnings, despite having 15 per cent earnings growth, it gives you some idea of the frustration we are feeling.
“Conversely, you’ve got Meituan Dianping. It's done well. Earnings are still below where they were pre-crisis, but the share price has gone up threefold. It's on 200x earnings and is a $200bn market cap company. Earnings have to deliver here, otherwise this company is really expensive.
“It's this divergence in individual stocks which we find quite frustrating at this point in time.”
Kerley said the low rating of China Railway Construction is fairly typical for dividend-paying stocks in the region. Pointing to valuations of top-quartile dividend-paying stocks in Asia relative to the index, he noted that this area of the market is the cheapest it has been since 2002, when global interest rates were much higher.
The manager said that what is most interesting about this graph is the period between 2011 and 2015, when the initial bounce-back from the financial crisis was followed by a period of anaemic growth.
“It's at that point that demand for yield is apparent and we get yield outperforming, to the point where it actually trades at a premium to the market,” he noted.
“To my mind, that's what happens to yield, demand for it doesn't change. And I think that's partly reflected in the fact that Henderson Far East Income trades at a premium: our performance isn't great and I admit that, for the reasons I've said. But the dividend yield of 7.4 per cent is attracting investors who require that income. And that's why we trade at a premium.”
Kerley said this is not the only way in which he thinks the recovery from the coronavirus crisis may emulate the aftermath of the financial crisis.
He noted that on average across the globe, it took three years for dividends per share to return to pre-crisis levels, with 25 per cent of those companies never fully recovering.
Yet in Asia, it only took about two years for dividends to rebound and he believes that the region looks just as prepared this time around.
“If we go back to the financial crisis, yes 45 per cent of companies in Asia cut dividends, but 32 per cent actually raised them,” he said, “and the forecast in 2020 is that around 30 per cent of companies will actually increase their dividends this year.
“Alright, 43 per cent cut. But for an income investor looking for cash flow generation and cash flow growth, you can still get it in Asia during a crisis. And I think that's quite interesting. It also shows that dividends are actually much more sustainable than I think people expect.”
But while dividend-paying stocks are out of favour across the globe, Kerley does not expect to see a sustained bounce-back in the developed world once the coronavirus crisis has been overcome. Although he anticipates further government stimulus, he warned high levels of debt and unemployment are suggestive of a fairly benign recovery, meaning value stocks will continue to struggle.
In addition, he said the enormous amount of debt means governments in the west will be reluctant to raise interest rates, removing another potential tailwind for value strategies. However, he believes it is a different story in Asia.
“The reason being, I think we are closer to a normal cycle in Asia,” he continued. “I think we do have a better chance of recovery.
“Our belief is that we will get a switch towards value in Asia, less so in the western world, and as a result the drivers of return will broaden. And this is especially true in China, where there's a lot of focus on Alibaba, Tencent and internet and healthcare stocks. I think if China continues to recover as it does, you won't need to pay the multiples of some of these companies in order to get access to growth.”
Data from FE Analytics shows Henderson Far East Income has made 181.6 per cent since Kerley joined at the start of 2007, compared with gains of 242.49 per cent from the MSCI AC Asia Pacific ex Japan index and 229.03 per cent from the IT Asia Pacific Income sector.
Performance of trust vs sector and index under manager
Source: FE Analytics
The trust is trading at a premium to net asset value of 1 per cent, compared with 1.65 and 1.63 per cent from its one- and three-year averages.
It is yielding 7.52 per cent and has ongoing charges of 1.11 per cent. It is not currently geared.