abrdn Asian Income Fund — Quality and value focus with an attractive yield

AAIF’s focus on quality companies that can grow earnings and dividends over the long term means that performance should lag in a strong market but perform relatively better in periods of market weakness, and this is borne out by the upside/downside analysis below. The fund has modest exposure to growth stocks whose valuations could continue to struggle if interest rates remain higher for longer.

Asia may not be front of mind when investors consider income generation. However, over the last 20-plus years, more than 50% of Asian equity total returns have come from dividends, and dividend growth has exceeded that in Europe and the US. AAIF offers an above-market dividend yield, helped by its exposure to the three highest-yielding markets in Asia: Singapore (AAIF is considerably overweight versus the MSCI AC Asia Pacific ex-Japan Index), Taiwan (overweight versus the index) and Australia (broadly in line). Seasonally, June to August is a strong period for dividend payouts and AAIF’s managers may increase the fund’s exposure to companies that pay annual dividends ahead of their distributions.

The low beta nature of AAIF’s portfolio is highlighted by its upside/downside analysis. Over the last decade its cumulative upside capture of 85.2% is very similar to its downside capture of 84.1%. As these numbers are below 100%, it implies that the fund will move around 15% less than the MSCI AC Asia Pacific ex-Japan Index during both rising and falling markets.

abrdn believes that ESG factors are financially material and affect corporate performance. MSCI has awarded AAIF an ‘A’ ESG score, and it has higher ratings in all three areas compared with its benchmark: environmental score of 5.7 versus 5.3 (at end-August 2023), social 5.1 versus 5.0 and governance 5.7 versus 5.1; the fund’s 6.3 ESG quality score compares with 6.0 for the benchmark.

Growth themes and specific company exposures within the portfolio include:

Within Asia, the managers consider that the region’s economies are generally in good shape. Compared with those in developed markets, Asian governments spent less during the global pandemic and have less debt, allowing them more fiscal and monetary policy flexibility. Corporate balance sheets are also less indebted than those in the West, providing more options for cash flow usage including investment in future growth, paying down debt or returning cash to shareholders via share repurchases or dividends. The Asian region is benefiting from manufacturers diversifying their supply chains, with less reliance on China; there is increased demand for production capacity in countries including Malaysia and Vietnam. Also, the Indian government is encouraging manufacturers into the country via tax breaks and reduced bureaucracy. Within the technology sector, growth in AI should be supportive for the businesses of Asian semiconductor and consumer electronics companies.

As shown in Exhibit 2, Asian markets look relatively attractively valued versus the MSCI AC World Index on all three metrics shown. This world index is dominated by the US (63% at end-October 2023), where valuations look stretched in both absolute and relative terms. AAIF’s managers note that Asia also has dividend support as, in aggregate, dividends have been growing steadily, with Asia having the best dividend growth compared with pre-COVID-19 levels versus the major markets. They anticipate that 2024 dividend growth will also be healthy, led by sectors such as consumer services and staples, and insurance.

Looking at AAIF’s geographic exposure in Exhibits 3 and 4, over the 12 months to the end of October 2023, there were modest changes. There were higher weights in Taiwan (+2.9pp) and China (+1.8pp) with lower allocations to Australia and Singapore (both -1.8pp). Compared with the MSCI AC Asia Pacific ex Japan Index, AAIF was materially underweight China (-20.5pp) with a large above index weighting to Singapore (+17.4pp), which is one of the highest yielding countries in the region. The fund also has underweight positions in India (-8.2pp) and South Korea (-3.4pp) as these are lower-yielding markets.

A large part of the Chinese index weighting is made up of internet companies that do not pay a dividend, while other sectors that do pay dividends, such as banks, are relatively less attractive compared to their regional peers in terms of both quality and yield. The underweight Chinese position has been beneficial for AAIF’s relative performance over the last couple of years as the Chinese stock market has rolled over. However, this positioning was detrimental during prior periods, when there was high demand for Chinese growth shares. The managers are mindful of problems within the Chinese property market as developer excess is being reigned in and they avoid speculative developers or those with high levels of debt, although the managers believe the industry offers select opportunities; AAIF has a holding in China Resources Land, which has a rental revenue-generating investment properties portfolio that is used to fund future developments and pay a sustainable dividend, but is trading below its estimated intrinsic value.

From a sector perspective, AAIF has an above-market exposure, with around a quarter of the fund, invested in technology stocks. At the end of October 2023, its top two holdings, TSMC and Samsung Electronics, together made up 13.5% of the portfolio and are favoured for their strong balance sheets and cash flow, along with dividend growth potential. Other technology positions include businesses in TSMC’s and Samsung’s supply chains and companies that are benefiting from the growth in AI. These Asian companies pay dividends, unlike some similar businesses in other regions.

AAIF’s second- and third-largest sector exposures are financials and real estate, which are widely represented in high-income funds. The portfolio has no exposure to healthcare and energy stocks, which make up around 10% of the MSCI AC Asia Pacific ex Japan Index, as they do not meet the managers’ required quality and income criteria. Healthcare stocks in Asia tend to be nascent businesses, unlike in developed markets.

At the end of October 2023, AAIF’s top 10 holdings made up 38.5% of the portfolio, which was 2pp higher than 36.5% 12 months earlier; nine names were common to both periods. The top 10 is a mixture of higher-yielding stocks; for example, utility and financial companies and dividend growth names such as TSMC and Samsung Electronics.

In September 2023, PT AKR Corporindo (AKR) was added to the portfolio due to its attractive valuation and a high single-digit dividend yield. AKR is one of the main players in industrial fuel distribution in Indonesia, a business that has a high barrier to entry. The company benefits from an extensive infrastructure and logistic network throughout the country. There is potential for AKR to accelerate land sales at its Java Integrated Industrial and Ports Estate (JIIPE). With government support for the JIIPE’s development, including tax incentives, AKR is well placed to reap the rewards as a utility provider to the area, which will help to support its dividend payments.

Two positions were sold in August 2023: China Vanke, as the investment thesis had changed due to the property developer’s increasing liquidity stress, and China Merchants Bank, as its management signalled continuing net interest margin pressure amid a weak economic and property environment.

There are five companies in the AIC Asia Pacific Equity Income sector (Exhibit 6). Three invest for income as well as capital growth: AAIF, Henderson Far East Income Trust (HFEL) and Schroder Oriental Income Fund (SOI). These companies have straightforward yields as their dividends are paid out of income. The other two funds, JPMorgan Asia Growth & Income (JAGI) and Invesco Asia Trust (IAT), make distributions that may be paid out of capital.

Unlike managers that take a barbell approach of investing in some businesses with a high yield and others that do not pay a dividend, all of AAIF’s portfolio companies contribute to the fund’s overall dividend yield, although exceptions are made for an IPO or a spin-off company that has committed to a future dividend payment.

In terms of NAV total returns versus the peer group, AAIF’s are above average over the last one, three and five years, ranking third, second and third respectively. Over the last decade it ranks fourth. The company’s discount is currently the widest in the group, which may seem unwarranted given its solid recent and mid-term performance and its quality growth and income focus. AAIF has the joint-highest ongoing charge, but no performance fee is payable, and the highest level of gearing, which should be beneficial in a rising market. It has the second-highest dividend yield of the whole sector and of the three companies that pay a dividend based purely on income.

AAIF’s relative returns are shown in Exhibit 7. It has outperformed the MSCI AC Asia Pacific ex Japan Index over the last three and five years. It is ahead of the MSCI AC Asia Pacific ex Japan High Dividend Yield Index over the last five years in both NAV and share price terms.

The company’s performance has been less successful over the last decade where, for most of the period, investors favoured growth stocks. Also, the portfolio’s underweight Chinese exposure over the last 10 years is likely to have been detrimental, although this positioning has been beneficial in recent years due to China’s strict COVID-19 lockdowns followed by lacklustre economic recovery, along with increased regulatory pressure imposed on some areas of the Chinese economy.

AAIF pays quarterly dividends in May, August, November and February. The FY22 total distribution of 10.00p per share was 5.3% higher year-on-year and was the first covered annual dividend in three years, following the global pandemic. The company has now paid higher dividends for 14 consecutive years. Revenue earnings per share were 10.23p in FY22, a 14.3% increase versus 8.95p per share in FY21. This was helped by the managers’ focus on high-yielding companies with strong fundamentals, where there is scope for higher dividend payments given strong cash flow generation and low distribution ratios in Asia.

The board announced that, barring unforeseen circumstances, the FY23 annual dividend will be at least 10.60p per share, representing a 6.0% increase. So far, three interim dividends of 2.50p per share have been declared, which are 8.7% higher year-on-year.

AAIF’s discount to NAV remains wider than those of its peers, despite the fund’s attractive dividend yield and focus on high-quality companies. Its latest 13.1% share price discount to cum-income NAV is towards the wider end of the 8.4% to 15.1% range over the last 12 months (Exhibit 11). This is not unexpected given heightened investor risk aversion during a period of economic uncertainty. Over the last one, three, five and 10 years, AAIF’s average discounts are 11.9%, 11.5%, 10.7% and 8.0% respectively.

The board’s policy is to repurchase shares when the share price discount to ex-income NAV exceeds 5% (in normal market conditions). In FY22, c 1.7m shares (c 1.0% of the share base) were bought back, at a cost of c £3.8m, and held in treasury. Modest share repurchases have continued in FY23 (Exhibit 12).

AAIF is a Jersey-registered, closed-end investment company that launched in December 2005. It is managed by abrdn’s Asian Equity team, which aims to generate an attractive total return from a diversified portfolio of Asia Pacific equities, including those with above-average dividend yields. AAIF invests across the market-cap spectrum and is unconstrained in terms of geographic and sector exposures. Its board follows a progressive dividend policy and the annual dividend has increased in each of the last 14 years. The fund’s performance is measured against the MSCI AC Asia Pacific ex-Japan Index. Relative performance versus the MSCI AC Asia Pacific ex-Japan High Dividend Yield Index is provided for reference. AAIF can invest in preference shares, debt, convertible securities, warrants and equity-related securities, as well as off-benchmark stocks (including Japan). A maximum 20% of total assets is permitted in a single issuer. Gearing of up to 25% of NAV (up to 15% in normal market conditions) is permitted. The managers may write covered put and call options, and undertake stock lending to generate additional revenue, although these features are used sparingly.

abrdn’s disciplined investment approach is based on three core beliefs: fundamental research can highlight market inefficiencies; over the long term, company fundamentals drive share prices, but in the shorter term, share prices can be mispriced; and ESG analysis and corporate engagement can enhance returns. Portfolio turnover is relatively low, averaging c 10–15% pa, implying around a seven- to 10-year holding period.

There is a four-step investment process:

abrdn has a proprietary research platform used by all its equity, credit and ESG teams. Research is focused on four areas: ‘foundations’ include how a company makes money, its competitive advantage, industry conditions, financial strength and the quality of its management team; ‘dynamics’ covers the shorter- and longer-term dynamics of a business that will drive long-term value, and which may not be reflected in a company’s share price; ‘financials and valuation’ considers the strengths and weaknesses of a company’s financial metrics, how a firm is valued and an analysis of dividend paying ability, along with the potential for dividend sustainability and growth; and ‘investment insight and risk’ is an articulation of the investment thesis, how value is expected to be created and how the view differs from the consensus.

abrdn has been actively integrating ESG into its investment process for 30 years and believes that ESG factors are financially material and can meaningfully affect a company’s performance. The managers cite evidence that shows shares of better-quality companies can perform better than inferior peers, investing in companies with better ESG scores can add to fund performance, and ESG analysis can help deliver a similar portfolio return while reducing investment risk.

AAIF’s portfolio has an ‘A’ ESG rating by MSCI, which is a leading external ratings agency. Environmental factors relate to how a company conducts itself regarding environmental conservation and sustainability. Social factors pertain to a company’s relationship with its employees and vendors. Governance factors include the corporate decision-making structure, the independence of board members, the treatment of minority shareholders and executive compensation. An ESG focus enables AAIF’s managers to glean additional insights from company visits and obtain an ESG information advantage. These meetings are important as Asian companies’ ESG disclosure can be poor, especially in certain markets such as China.

abrdn’s Asia Pacific equity team has around 40 people, of which three are ESG specialists. The company is an active investor that votes at shareholder meetings, works with companies to drive positive change and engages with policymakers on ESG and stewardship matters. abrdn does not invest in tobacco companies or firms directly exposed to controversial weapons. Following extensive due diligence and research, abrdn’s research analysts assign an ESG score of 1 to 5 to each company under coverage. The company has aligned its approach with that advocated by the investor agenda of the Principles for Responsible Investment, which is a United Nations-supported initiative to promote responsible investment to enhance returns and better manage risk.

Recent company engagements by AAIF’s managers include with Rio Tinto regarding its proposed changes to its remuneration policy, which are scheduled to be tabled at its 2024 AGM. abrdn had questions about several aspects of the proposals, including those related to performance measures, vesting thresholds for the long-term incentive plan and share deferral requirements for the annual bonus.

AAIF has a £40m multi-currency revolving facility with Bank of Nova Scotia, London Branch. At end-H123, £30.1m was drawn down as follows: £15.8m at 5.66090%, US$8.85m at 6.36448% and HK$73.5m at 5.94964%. The company also has an unsecured fixed £10m credit facility with Bank of Nova Scotia, London Branch, at an all-in interest rate of 1.53%. Both facilities mature on 2 March 2024. At 8 December 2023, net gearing was 6.2%.

abrdn receives an annual management fee of 0.8% of AAIF’s rolling monthly average NAV over the previous six months, up to £350m, and 0.6% per year above £350m. Fees are charged 40:60 to the revenue and capital accounts respectively, in line with the expected split of returns between income and capital; no performance fee is payable. In H123, AAIF’s ongoing charges were 1.01%, which were in line with FY22.

AAIF is an investment company with one class of share; there are 167.4m ordinary shares in issue, with a further 27.6m shares held in treasury. Its average daily trading volume over the last 12 months is c 176k shares.