Kate Lin: Welcome to Morningstar. Asia stocks are trading at an attractive level in terms of valuations as a whole, and the potential for mean reversion piques the interest of global investors as China is expected to pull the stimulus trigger to rescue the economy from its own property crisis. Another aspect under watch is how China, along with other markets in the region, could benefit from a monetary policy impetus.
In this environment, why does it make sense to use a dividend equity strategy to invest? We're speaking with Julie Ho, a portfolio manager from JPMorgan Asset Management.
Cash Vs. Dividend
So Julie, hello. Fund managers and advisors alike are advising clients to move away from fixed deposit or cash and re-enter the market. Can we have your views and your focus on allocating to Asia?
Julie Ho: Sure. So I know cash feels very cozy, but when you think of cash, money market deposits, or fixed income, but it's the name says it all, it's a fixed item. So really it's there the rates are higher to compensate for the higher inflationary pressures received in the society. So on a real growth basis, there is none to speak of.
And so of all asset classes, it's really only equities that provide the real growth. Now as we see rates can start to fall as Fed funds rates fall, I think investors really need to start thinking about their reinvestment risk. And what we try to do in equity income is really to balance out the need for the dividend, which we also pay on a monthly basis, as well as that capital return. So it's really a dividend plus long-term growth strategy.
And now what makes Asia very fertile ground for this type of strategy is we have an abundance of opportunities across many, many markets and across many sectors. So what's special about Asia is we not only have the developed markets, but we also have the emerging markets. So the developed markets give us very much of that higher dividend because the payout ratios tend to be higher, while it also tends to have a more stable growth outlook, whereas emerging markets tend to give you that growth push.
So in the portfolio that really combines both these markets, you end up with one that has a very attractive dividend as well as that long-term growth potential. And I think really when you combine this, one of the features of a dividend-yielding fund is also that it tends to have a lower beta than the broader market.
Choosing High Yielders
Lin: So when it comes to selecting these stocks that fit into your portfolio, what criteria do you use?
Ho: So we're really strict about the income stock criteria, and every single stock needs to fit that definition, which for us is one that is higher than the median yield of the market. So currently that's around 2%, but tended to be around that level. And once it satisfies that criteria, we don't go for just the highest dividend yielder or we don't really go for like the cheapest stock.
One very important thing about being a dividend investor is it keeps us very grounded to the need for being very disciplined on valuation. So what we look for are really the everyday stable growers. So they tend to be already profitable, but they also have very healthy balance sheets and free cash flow. And what's very important is also the management teams' ability and willingness to part with that free cash flow in the form of a dividend to give to investors. And that willingness to have an appropriate payout policy is also an indication of their visibility on the future business as well as how we perceive the corporate governance of the business.
So I think to summarize, it's really one of stable growth. And then also, with that higher visibility that comes with the dividends' willingness, is why we have a portfolio that tends to be lower beta than the broader market.
3 Sector Picks
Lin: Right, and in terms of markets and sectors, which do you prefer or avoid?
Ho: So there are a few markets that our portfolio is currently overweight, and to emphasize, we are very much of a bottom-up driven shop. And so really where we are overweight comes back to where the abundance of opportunities and stocks screen attracted to us.
So currently we have three areas. The first is Australia. Recently I was in Australia for a week and met 35 companies, and I really came back being very impressed with the strong demographic growth in Australia. So it's one place that gets every very consistent 1 to 2% population growth. And that combined with a very supportive fiscal policy gives Australia a lot of domestic growth elements and actually makes it somewhat shielded from what's happening on the global landscape.
So in Australia, it's really a broad sleeve of opportunities ranging from financials to defensive stocks and even energy stocks that we could invest in. Now going into the emerging markets area, an area we also like is Indonesia. And so here we mostly find opportunities within Indonesian banks and also Indonesian telcos.
So we do think that banks are very macro-dependent, macro interrelated, and we're quite impressed with the very stable loan growth that we're seeing around 10 to 12% loan growth, which according to our own analysis and our bank analyst's view, is a sweet spot, not too high, not too low. And the third area I would say really comes down to the opportunities within the tech space. So within tech, it's not only the semiconductor and the food chain space that we find opportunities in, but really also in the IT services sector that's mostly represented in the Indian market. So it's a broad sleeve of IT from semiconductors or more upstream to really the servicing companies that we're finding opportunities in.
The Role of Options Overlay in an Income Portfolio
Lin: There is an interesting mechanism called options overlay in your portfolio. How does it work and how can investors gain from it?
Ho: Sure. So in this portfolio, we'll be using index level option overlay. And so why we're using index overlay is really in Asia, especially it's very liquid, and we find that it's a very effective way of transforming future capital gains into today's income.
Now, as we spoke about before, because the starting dividend yield in Asia is very attractive, the portfolio doesn't need to use too much option overlay. We'll be using a consistent 30% call overlay to juice up the income of the portfolio, to get it to that consistent 7 to 9% level. And what the call overlay provides to us is not only the higher income, but we talked about is actually in addition to the equity portfolio itself having the lower beta, you have the call option overlay further reducing the beta of the full portfolio.
And thirdly, because we're only using 30%, this allows for the remaining 70% of the portfolio to be unencumbered to the upside. So in other words, you still have 70% of the portfolio that's completely able to capture the beta of the market. And importantly, because we're using an index level call option overlay, we still have 100% of our alpha generation capability preserved in the strategy.
Lin: Awesome. Thank you so much for your time and insights, Julie. For Morningstar, I am Kate Lin.
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