Allianz Global Investors White Paper Series January 2017 Dividends in Emerging Markets: Buy the High, Sell the Low Investors are clamoring for income via bond and equity strategies in the wake of today s financially repressed market environment. The search for equity income has historically led investors to developed markets, primarily the United States, with many overlooking the more attractive opportunity set in emerging markets. Besides their sought after income qualities, high dividend stocks in emerging markets can provide an added benefit of superior down market protection and have meaningfully outperformed their low dividend and non-dividend counterparts 1. Dividends are an important building block to any portfolio, particularly in a historically low yielding environment Emerging market stocks currently offer some of the most attractive yields on the planet High dividend stocks have meaningfully outperformed low dividend stocks in emerging markets, 1 a trend we expect to continue for the foreseeable future Why do dividends matter? Dividends are a key piece of the investment puzzle, allowing companies to redistribute a portion of their earnings back to investors. Dividends help ensure that companies are good stewards of their capital and have the foresight to effectively manage company assets to meet ongoing dividend payments. From an investor s standpoint, dividends provide a relatively dependable source of income. Over time, dividends can represent a meaningful share of a company s profits, tend to be more stable than earnings, offer protection against inflation and provide a consistent investment return. The case for dividends is especially true in emerging markets. To validate this point, we dissected the MSCI Emerging Markets Index by starting with the total return and subtracting the price return to derive the dividend contribution shown in exhibit 1. Since the benchmark s inception in 1987, the dividend contribution has been the lion share of performance contributing a whopping 968% 2. To think about it in a different light, 56% of an investor s emerging market performance over time is the result of dividends. The historical contribution from dividends, coupled with today s low yielding environment for assets globally, suggest dividends will continue to be in high demand by investors. 1 Performance post the financial crisis, from March 1, 2009 to December 31, 2016. 2 Source: MSCI, cumulative returns from December 31, 1987 to December 31, 2016.
The importance of dividends Dividends can represent a meaningful share of a company s profits Dividends have been more stable than earnings over the long-term Dividends can offer better protection against inflation than bond coupons Dividends can provide a consistent return on an investment Exhibit 1: MSCI Emerging Markets Index Cumulative Performance Cumulative Performance 2500% 2000% 1500% 1000% 500% MSCI EM Index: Total Return MSCI EM Index: Price Return Dividend Contribution = 968% 1731% 762% 0% 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: MSCI, monthly data from December 31, 1987 to December 31, 2016. Exhibit 2: % of Dividend Payers in the Benchmark 95% Percentage of Dividend Payers in Benchmark 91% 90% 85% 83% 80% MSCI EM S&P 500 Source: FactSet as of December 31, 2016. The global hunt for yield In today s financially repressed environment, investors are clamoring for yield. Markets in the U.S. have long been seen as the best places on the planet given their global reach, significant size, reserve currency status of the dollar and attractive dividend yields. In addition, dividend payers are fairly prevalent in the U.S., with 83% of stocks in the S&P 500 paying dividends 3. Investors may be surprised to find that in emerging markets, which is typically deemed less financially advanced, the percentage of dividend payers is actually higher, with 91% of stocks in the MSCI Emerging Markets Index paying a dividend 4. Not only do dividend paying companies in the MSCI Emerging Markets Index make up a larger percentage than those of the S&P 500 Index, few investors may realize that post the financial crisis 5 emerging market stocks have consistently offered 3 Source: FactSet, as of December 31, 2016 using the S&P 500 Index as a proxy for the United States 4 Source: FactSet, as of December 31, 2016 using the MSCI Emerging Markets Index as a proxy for Emerging Markets 5 The global financial crisis is defined as post March 2009. 2
Exhibit 3: Dividend Yield of Benchmark 4.0 MSCI EM Index S&P 500 Index Dividend Yield 3.5 3.0 2.5 2.0 1.5 06/09 12/09 06/10 12/10 06/11 12/11 06/12 12/12 06/13 12/13 06/14 12/14 06/15 12/15 06/16 12/16 Source: FactSet, monthly figures as of December 31, 2016. more attractive dividend yields as shown in exhibit 3. This speaks to the importance of dividends in the asset class and that investors should recognize emerging markets as an attractive place to hunt for income. Which companies pay dividends in emerging markets? The MSCI Emerging Markets Index offers broad economic exposure, consisting of over than 800 stocks across 11 sectors and 23 countries 6. So where are the best places for investors to search for yield? If we start by dissecting the benchmark into sectors, we see that higher yielding sectors are comprised of Telecommunication Services, Real Estate, Utilities and Financials, while lower yielding benchmark sectors include Health Care, Consumer Discretionary and Information Technology. The yield separation between the highest and lowest yielding sectors is roughly 2.8%. This relatively low dispersion suggests that investors can build a diversified portfolio of dividend-oriented stocks, without the worry of being overly concentrated in just a handful of sectors. When comparing the dividend distribution across countries in the MSCI Emerging Markets Index, there is a much more meaningful separation in dividend yield. The highest yielding countries range from 8.4% in a small, and relatively concentrated country like the Czech Republic and 4.8% in Russia, to the other side of the spectrum with the lowest dividend yielding countries like Peru, Greece and India with yields below 1.2%. Investors can capture income generation from the higher dividend yield countries between 12 o clock and 6 o clock as shown in exhibit 5, and complement this exposure with capital appreciation potential via lower dividend yield countries between 6 o clock and 12 o clock of that figure. This allows for the dual benefits of income generation and capital Exhibit 4: Dividend Yields by Sector 7 Dividend Yield by Sector 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Consumer Discretionary Consumer Staples Energy Financials Health Care Benchmark Dividend Yield Industrials Information Technology Materials Real Estate Telecom Services Utilities Source: FactSet as of December 31, 2016. 6 As of December 31, 2016. 7 Source: FactSet, as of December 31, 2016. 3
Exhibit 5: Dividend Yield Clock by Country 8 Capital Appreciation Greece Peru India Philippines Korea Hungary Mexico Lower Dividend Yield Egypt Czech Republic 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 United Arab Emirates Russia Higher Dividend Yield Taiwan Qatar Brazil Colombia South Africa Malaysia Income Generation Indonesia China Chile Thailand Poland Turkey Moderate Dividend Yield Source: FactSet, AllianzGI as of December 31, 2016. appreciation, avoiding any potential concentration risk. This combined income generation and capital appreciation focus also allows for greater potential from stock selection, broadening the opportunity set for active management. Not All Dividends Are Created Equal Now that we have highlighted the importance of dividends and their prevalence across sectors and countries, let s further segment the benchmark and quantify the specific virtues of dividend paying stocks. Specifically, we have compared the above median dividend payers 9 (deemed high dividend ), below median dividend payers (deemed low dividend ) and non-dividend payers to get a sense of their attributes with respect to rolling volatility, down market protection and last but certainly not least performance. Dividends & Volatility We compared the volatility of these three segments using monthly figures post the financial crisis 10 and included the MSCI Emerging Markets Index as a point of reference. Exhibit 6 compares the rolling Exhibit 6: Rolling 36 month volatility Rolling 36 Month Volatility 40 35 30 25 20 15 10 5 0 03/12 06/12 12/12 06/13 12/13 06/14 12/14 High Dividend Low Dividend Non-Dividend Payers MSCI EM Index 06/15 12/15 06/16 12/16 Source: Worldscope, AllianzGI monthly figures from March 1, 2009 to December 31, 2016. 8 Source: FactSet, as of December 31, 2016. 9 Source: FactSet, the median dividend yield was 2.4% as of December 31, 2016. The high dividend payers and low dividend payers each represent approximately 45.5% of the universe, and non-dividend payers the remaining 9%. 10 Source: MSCI, monthly figures from March 2009 to December 2016. 4
Exhibit 7: Upside capture vs. downside protection Average Monthly Performance (%) 6 5.5 5.2 5.4 4 2 0-2 -4-6 Up Market (50 Months) -3.3-3.7-5.0 Down Market (44 Months) High Dividend Low Dividend Non-Dividend Payers Source: Worldscope, AllianzGI monthly figures from March 1, 2009 to December 31, 2016. 36 month volatility, indicating that over time there is little separation between high dividend and low dividend payers compared to the benchmark. However, there is a clear delineation between the non-dividend payers, which consistently delivered higher levels of volatility. The difference in volatility between dividend payers and non-dividend payers further cements the case that dividend stocks can provide investors with a greater level of stability. Dividends & Upside vs. Downside Protection Next, we measured performance across the same three segments to calculate average upside and downside market participation 11 to provide insight as to when each segment may add value over time. Not only do high dividend stocks outperform slightly in up markets, more importantly they provide a meaningful capital protection buffer in down markets. This greater level of protection appeals to investors and may translate to high dividend paying stocks being less impacted by short-term market dynamics. The superior down market protection is analogous to dividends providing relative safety (a bird in the hand), which may be worth more than simply capital appreciation (two birds in the bush). Dividends & Performance Finally, we compare performance across the three segments and again added the MSCI Emerging Markets Index as a point of reference. The cumulative results post the financial crisis show a significant level of outperformance for the high dividend payers, which have meaningfully outpaced low dividend payers, non-dividend payers and the MSCI Emerging Markets Index. The outperformance level has been relatively stable across the measurement period, which suggests a persistent premium for high dividend stocks over time. Exhibit 8: Cumulative performance Cumulative Performance (%) 300 250 200 150 100 50 0 06/09 High Dividend Low Dividend Non-Dividend Payers MSCI EM Index 12/09 06/10 12/10 06/11 12/11 06/12 12/12 06/13 12/13 06/14 12/14 06/15 12/15 06/16 204.3 121.2 114.5 23.7 12/16 Source: Worldscope, AllianzGI monthly figures from March 1, 2009 to December 31, 2016. 11 Monthly figures from March 2009 to December 2016 using the MSCI Emerging Markets Index as the definition for up vs. down market. 5
Concluding Thoughts Investors should take a fresh look at the sources of income in their portfolio. Emerging market stocks can offer superior dividend yields relative to U.S. stocks, which has long been seen as the gold standard for income. In addition, emerging markets trade at attractive valuation levels relative to developed markets, due in part to their relative performance challenges in 2013 to 2015. Now may be an opportune time for investors to rethink their emerging markets allocation, as most investors tend to be underweight the asset class relative to its global opportunity set. Clearly, a prudent way to achieve this emerging markets exposure is through high dividend stocks. A high dividend strategy may provide the added benefits of superior up market capture and down market protection, which could translate into a meaningful level of outperformance over low dividend and non-dividend payers. The fact that investors should continue to demand yield in today s financially repressed environment, suggest the demand for high dividend stocks should continue for the foreseeable future. Why high dividend payers? High dividend payers have historically provided greater levels of income with benchmark-like levels of volatility High dividend payers have historically delivered better upside capture and superior down market protection High dividend payers have outperformed low dividend and non-dividend payers, particularly post the financial crisis Investing involves risk. The value of an investment and the income from it may fall as well as rise, and investors may not get back the full amount invested. Past performance is not indicative of future results. There is no guarantee that any opinion, forecast, or objective will be achieved. 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