It is what investors do along the way that is most important, according to Fidelity Worldwide Investment (Fidelity).

“The outlook for the new financial year may seem to be a ‘groundhog’  year, with an apparent repeat of the past 12 months,” says John Ford, Chief Investment Officer Asia Pacific at Fidelity.

“There will be continued market volatility, downgrades, rescue packages, quantitative easing and continued concern of China slowing. We have seen all these in the past 12 months and look like seeing them again this financial year.

“Politics will drive markets this year. Ongoing global debt reduction will slow global economic growth for a sustained period.

“However, while it is expected to be a low growth world, not all sectors are performing poorly. Some have done and continue to do well.

“Investing in assets that provide real returns irrespective of daily market movements is more important than ever,” says Mr Ford.

“One way to do this is by investing in corporate assets, as much of the corporate sector is doing better than governments and sovereign investments.

“Assets like corporate bonds, high-dividend paying companies and some property funds are rewarding investors whether the market moves up or down.

“Corporate balance sheets, in particular in Asia, are stronger than ever. Many companies have paid down debt and locked in low interest rates and continue to generate income.

“Many of these corporates are rewarding their investors with returns, be it dividends or bond yields.”

Equity market
Mr Ford notes “dividends will form an increasingly important part of returns to shareholders. While, for the past 20 years, investors have bought equities for capital growth it is the time to buy equities for income. Studies show that investing in income-generating shares (and reinvesting the dividends) is one of the most lucrative ways to invest over the longer-term thanks to the compounding effect on returns. History shows that high-dividend stocks tend to outperform other assets in periods of sluggish economic growth – which is exactly what we face now. Companies that pay dividends are often high-quality companies with stable and reliable earnings streams that tend to hold up well during periods of market volatility. Dividend-focused indices have tended to outperform the broader averages so far this calendar year.

“Yet at present, whether a company is a good quality company, low quality company, high growth, low growth; they are trading around very similar ranges. We think there should be differentiation, there should be discernment in the market – and there will be at some stage – and that’s where we see opportunities for longer-term investors.

“Asian companies that can deliver a high and sustainable dividend yield or are still growing in today’s low-growth world, or both, will be bid up by the market. They are the ones we want to own. If you have an investment horizon beyond the next year or two they should provide a nice investment opportunity.”

Fidelity’s portfolio managers tend to favour companies with strong balance sheets, which do not rely on banks for funding. We also look for firms that own assets where supply / demand is tight, which sell products that all of us need on a daily basis, or companies that are doing something truly innovative, which gives them pricing power. These are what most of our managers want to invest in.

Institutional investors in Asia – such as pension funds, insurance companies and sovereign funds – are already increasing their investments in equities. Wholesale and retail investors will follow these institutions – eventually.

Fixed income
Among fixed income investments, Mr Ford notes “there have been substantial inflows into the traditional havens of US 10-year Treasury-bonds and German Bunds. We have also seen investors moving into other high-quality bond markets such as Canada and Australia, in an effort to escape eurozone uncertainty. But long term, the levels of their interest rates are unsustainable and will weaken.

“Our portfolio managers favour high-yield and investment-grade corporate bonds; again because many of the corporates that are offering them are in comparatively good financial shape.

“We’ve also seen an increased appetite for Asian bond markets, as many Asian economies do not have the same debt problems faced by the eurozone and many other developed markets. In particular, demand for Asian investment-grade bonds is increasing. Investors are also looking at Chinese RMB bond funds, where the appreciation of the currency is now available to global investors.”

Mr Ford notes there are also investment opportunities in the property sector. This is generally funds investing in second-tier property, which is starting to catch-up toward prime prices in some markets. But you have to be selective.

Looking at foreign exchange markets, traditional currencies such as the US dollar, Swiss franc and the yen have performed predictably well, while emerging market currencies have suffered.

Which countries?
Another factor in Asia’s favour is falling inflation and the healthy fiscal positions of many Asian governments. Mr Ford notes “China, Hong Kong, Singapore and South Korea all have strong budget surpluses, which give their governments more room to act if the global economy slows down further. In fact, we see scope for eight out of 10 central banks in Asia to cut interest rates. This lower inflation and the return of more growth focused policies should be positive for Asian equity markets.

“Markets where we are finding investment opportunities include Indonesia, South Korea and Thailand. For example, Indonesia is expected to be one of the next countries to join ‘club’ of countries that generate a GDP of more than a US$1 trillion a year.  Only two emerging market economies, South Korea and Taiwan, have had sustained GDP growth of over 5% for five decades.

“We also like companies in China and Korea for their attractive valuations with single digit price to earnings rations (P/Es). Thailand just reported GDP of over 11% in Q1 versus Q4 as the country recovers from the floods there late last year and continues to demonstrate healthy domestic demand.”

Mr Ford points out that “asset allocation is no longer a decision of how much to invest into fixed income compared to equities and how much diversification into property, alternatives, commodities or other asset classes. It is more about the types of assets in each class. And that allocation will vary with each investor’s risk and retirement requirements.”

He acknowledges that investing in Asia, be it Asian equities or high yield bonds, in today’s volatile markets is not without risks, such as external shocks from the issues in Europe and the US. This is why he suggests an active bottom-up approach to find the best investment opportunities, assessing individual investment opportunities and individual companies – as each country and company is impacted by macro events differently.

 4 July 2012 

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity Worldwide Investment. This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs.  You should consider these matters before acting on the information.  You also should consider the Product Disclosure Statements (“PDS”) for respective Fidelity products before making a decision whether to acquire or hold the product.  The relevant PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading from our website at www.fidelity.com.au. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Details about Fidelity Australia’s provision of financial services to retail clients are set out in our Financial Services Guide, a copy of which can be downloaded from our website at www.fidelity.com.au. © 2012 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity Worldwide Investment and the Fidelity Worldwide Investment logo and F symbol are trademarks of FIL Limited.

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Mr Ford says Asia will emerge stronger from the current financial storm – at least relative to the developed world – as there is a heavy price to pay for all the bail outs, recapitalisations and fiscal stimuli that have taken place in the developed world.

Cash-rich companies in Asia, ex-Japan are sitting on around $US1 trillion in cash and are also looking to deploy these funds by finding quality merger and acquisition targets with attractive valuations.

Strong balance sheets and a reduction in capital expenditure are also behind the build-up of corporate cash reserves, he said. “People don’t tend to associate income with Asia, but we are seeing a growing trend of Asian corporates undertaking share buybacks, special dividend payments and even M&A activity,” Mr Ford said.

He said the dividend income growth story would continue for some time and that dividend payouts were not associated just with infrastructure stocks. “We are seeing airlines, heavy industrials, and Taiwanese technology, media and telecommunications companies paying healthy dividends, as well as what you would expect from typical defensive stocks such as banks.”

In contrast to the West, Asia is in good fiscal shape on the sovereign, household and corporate front. According to the International Monetary Fund, the G20 advanced economies had a debt-to-GDP ratio of more than 100% in 2010. This figure is projected to rise to 125% by 2015. 
However, public debt levels are around one-third of GDP in Asia ex-Japan and are projected to decline to less than one-fifth by 2015. 

On consumer spending, Asian households can afford to spend more given the very low levels of household debt. 

Demographic factors and high savings rates will come down over time as the Asian population becomes increasingly middle class. This means that spending will accelerate in the future, translating into structurally higher levels of economic growth, particularly relative to those of developed world economies where households are necessarily focused on debt repayment.   

On the corporate front, Asian companies with healthy balance sheets are in a strong position to weather the current market volatility and reward shareholders with higher dividend payments and share buybacks.  The cash-payout ratios are set to increase further from 12% in 1998 to a prospective average of 32% estimated for 2011-12.

“This is significant because it shows us how strong corporate balance sheets are and how strong profits and cashflow are in Asian companies. It also shows a marked change in attitudes to good corporate governance and concern for shareholders’ interests,” Mr Ford said.

“This focus on shareholder value – coupled with robust balance sheets and healthy profits – means that over time an increasing proportion of total return from investing in Asian equities will come from dividend income and share buybacks rather than purely capital gain. In an environment so full of uncertainty, the well-covered yields in Asia are likely to become increasingly valued by investors,” he added. 

These are long-term strategies and a reflection of Asian companies getting more sophisticated and wanting to provide more value to shareholders.

Despite the current market turmoil, Mr Ford said Asia was the key winner out of the situation. “Companies in Asia remain healthy. The fundamentals are in good shape and foreign investors will once again look to this part of the world for growth and further income.”

“The bull case for Asia is not just about growth – it is about better governance, better balance sheets, better profits and cashflows, and therefore, attractive yields. Yet, Asian valuations have often remained at a discount to developed markets despite all of this,” Mr Ford said.

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