Why UK investors should go overseas for income

While UK shares are cheap, the same argument can be made for shares in the Asia-Pacific region, which is where the latest fund manager to appear in our Insider Interview series invests.

Edmund Harriss, who oversees Guinness Asian Equity Income, explains the benefits of UK income-seeking investors investing overseas. He  tells interactive investor’s collectives editor Kyle Caldwell that he rarely trades, having last made a new purchase in 2022, names companies that have delivered consistent dividend growth, and reveals the attributes he seeks in “high-quality” shares. 

Guinness Asian Equity Income is one of ii’s Super 60 fund ideas.

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Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. In the studio I have with me Edmund Harriss, fund manager of the Guinness Asian Equity income funds. Edmund, thanks for coming in today.

Edmund Harriss, fund manager of the Guinness Asian Equity income fund: Nice to see you.

Kyle Caldwell: So, let’s start off by talking through your investment process. You look for high-quality shares that pay sustainable dividends. So, what are the main qualities or attributes that you’re looking for?

Edmund Harriss: Our focus is very much on the companies themselves, the operating assets, and whether we believe that they can continue to generate the cash flows needed to produce a dividend.

From a top-down perspective, that means we’re looking for companies that have sustainable competitive advantages, that are making things or providing services that people want to buy, and doing it better than their peers.

In times of more challenging circumstances, they are the go-to company for whatever product or service it is. So, it is about good-quality businesses, but distilled down into those that are translating those strengths into cash flows that will fund the dividends that we seek.

Kyle Caldwell: Could you give us a couple of examples of companies that you’ve held for a while that have delivered consistent dividend growth?

Edmund Harriss: Yes, well, we have an approach of looking at good-quality companies that leads us to hold stocks for quite a while. If they've got a sustainable competitive position, then the expectation is that they will continue to sustain that. One example is JB Hi Fi Ltd (ASX:JBH) in Australia, an electrical retailer. It is selling household durables, but also audio visual equipment, games and so forth. They have diversified a little bit more into household products, but it is a really competitive market in Australia.

What management has managed to demonstrate over time is an ability to control costs, so they can maintain their pricing point. They have managed to fend off the advances of Amazon into that market. So from that, the business has been able to grow the dividend year on year. They did particularly well, during the Covid period [when people were] working from home. They have sustained that, subsequently. So, that is a stock that we’ve held since the fund was launched in 2013.

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The second stock example is Novatek Microelectronics, a Taiwanese semiconductor designer and manufacturer. Retail investors here would not be able to buy that stock, but we’ve also held that since 2013. The company designs chips that are used to drive and control displays. So, screens on handsets, screens on TVs and consumer durables.

One of the things that has marked out their design is their ability to cooperate multifunctions on a single chip. It is efficient, space saving, and it is also energy efficient. In short, that’s why manufacturers are using these chips in their devices. The company profits have grown steadily. Over the last 10 years, dividend payouts have increased. And so in common with many Taiwanese hardware manufacturers, it has been a consistent dividend payer over the 10 years that we’ve held it.

Kyle Caldwell: For investors considering investing in Asia ex-Japan, they’ve got two options. They could go for growth or, like your strategy, go for income. What would you say to an investor to consider income over growth?

Edmund Harriss: What I would say to investors going into the Asian region is that it makes most sense to go into companies that have long-term, sustainable competitive advantages, that have translated that into superior returns on capital, and they shouldn’t necessarily be looking for a growth or an income approach, but looking at companies that have solid, sustainable business plans.

The types of businesses that we’re investing in are growing businesses,  there is growth there. What we’re looking for are those ones that are generating more cash than they need for reinvestment. So, they are reinvesting in their businesses, but generating surplus cash. It is that that provides the dividend stream.

The reason you would look for income in the Asia-Pacific region is that these companies trade on lower valuations than their developed market peers. Looking at companies the way that we do with returns on capital above the cost of capital sustained over time, so solid profitability is quite hard to find. There are only comparatively few companies around the world that have achieved this on a sustained basis, year after year after year. But Asian companies still tend to trade rather more cheaply, so you’re paying less per pound of income, and that is what’s giving you a higher dividend yield.

Kyle Caldwell: You mentioned valuations. At the moment, the UK stock market is trading on a very low valuation compared to its history. So, why should an income-seeking investor go to Asia rather than stay in the UK?

Edmund Harriss: Really it’s the variation in sources of income. In the UK market, the big sources of income are from the financial sector or from cyclical businesses like miners and commodities, where prices go up and prices come down again. So, you get the variation in cash flows. These companies have tended to pay high dividends and so it is a useful source. But what Asian companies offer is a diversity in income streams. So, these are from manufacturers and service providers that are either serving export markets for Asian companies that are producing goods that are exported to developed markets in the US and Europe.

Possibly more interestingly, it is companies that are serving the Asian consumer. Over the last 25 years or so, household incomes have grown. A consumer marketplace has developed. There has been a widening wealth effect. So, companies that are now servicing this area are also producing cash. So, you’ve now got quite a wide variety of income sources. [As] a UK investor you have now diversified the sources of your income, and if you can see similar sorts of reliability, and we argue that we can, then that makes it a very interesting place to go if income is one of your priorities. But I would emphasise that it is the growing income stream that I think is probably what an income investor ought to be focusing on.

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Kyle Caldwell: The fund has a yield of around 4% in terms of dividend growth. Could you put some figures on each year? What’s been the typical dividend growth over the past 10 years since the fund was launched?

Edmund Harriss: It’s grown on average 4% a year. In sterling terms, we have a bit of variety when we’re thinking about what we expect to see from the dividend stream that comes from the fund. So, you’ve got various currency effects and so forth, but the distribution has grown at a reasonable pace we would argue; 4% a year. I think it is quite attractive. The yield on the fund has averaged 4% over the life of it. I think the lowest annual yield was around 3.6% and the highest has been about 4.6%. What we’re looking for is a steady compounder over time with an output that in return terms is coming from profit growth, and from dividend growth year on year.

Kyle Caldwell: It’s a concentrated portfolio with 36 stocks and it’s typically an equally weighted approach. Could you talk us through both those elements?

Edmund Harriss: A 36-stock portfolio, as you say, so reasonably concentrated. They all have the same underlying investment case; that the returns on capital achieved by these businesses in the past are likely to persist, but are priced by the market as if they won’t. They all have a similar characteristic, that the profits are coming through in cash terms, that they’re reinvesting a part of that and are distributing the rest. So, all the companies themselves are dividend payers.

They’ll be different stories behind each of these different geographies, different sectors, different underlying themes. But, from an investment perspective, all these income producers have the same sort of investment characteristics, and that reflects our view that we can have high confidence in the ability of the company’s operations to perform, but we don’t know what the market’s assessment of those companies is going to be at any given moment. So, let’s not try and call that.

If we like the company and it is undervalued relative to what we think the cash flows and the profits are worth, then it goes into the portfolio, and it’ll go in at 2.75%. Then we’ll let the market take [them] wherever it may be. Some will outperform at some period, some will underperform. You can rebalance to that and you can use market fluctuations to your advantage in the portfolio.

But the core view is that we think we’ve got 36 good companies that are undervalued and that that valuation will come through at any given point. In the meantime, each year they will be throwing off excess cash, paying out between 30% and 70% of their profits for that year, and we will see that come through. The share prices themselves will oscillate. During periods of stress, they might widen quite considerably, but they will come back into line if the profits and the dividends repeat as we expect they will year on year.

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Kyle Caldwell: When you identify a new investment opportunity, is it a one in, one out policy? And could you name your most recent purchase?

Edmund Harriss: Yes, it is absolutely on a one in, one out basis. We don’t change many names in the portfolio. We didn’t change any names last year, for example. So, we’ll have to go back to 2022 for an example. One was a move out of KT&G [Korea Tobacco & Ginseng Corporation] in South Korea, which is a consumer staple and with some real estate associated with it. It was one of the higher dividend-yielding stocks in Korea, but we moved out of it because profits weren’t growing, the dividend stream wasn’t growing. That, we believe, will lead to underperformance and pressure over time.

A growing income stream is what is considered to be more important. We bought Industrial And Commercial Bank Of China Ltd Class H (SEHK:1398) in Hong Kong, a bank trading at very low valuations, [with] a high dividend yield. We’ve held it before but [it was] trading very cheaply due to concerns in Hong Kong and China about the health of the financial system. We hold a different view, so this represented a great opportunity for us. More importantly, it’s been growing its dividend by between 5% and 10% a year, whereas KT&G has not.

Kyle Caldwell: Edmund, thanks for your time today.

Edmund Harriss: Thank you.

Kyle Caldwell: That’s it for our latest Insider Interview. I hope you’ve enjoyed it. You can let us know what you think, you can give us a like, subscribe, comment, and hopefully I’ll see you again next time.