Are China A-share companies the next dividend opportunity?
Yu Zhang, CFA - Portfolio Manager, Matthews Asia
Much has been written about the decision to include China A-shares in the MSCI Emerging Market Index. The symbolic importance cannot be overlooked. Whether it will have a significant impact on investor portfolios, however, remains to be seen.
One change in the A-share market performance since its inclusion is notable. Year to date, the broad market performance of China's A-shares is likely to rank at the bottom versus other Asian markets, but this underperformance has not been across the board. Beneath the surface, a group of companies has performed strongly. International investors would classify them as stocks of blue-chip businesses with low multiples and at relatively low valuations.
Why is this significant? In my view, it is not due to non-domestic investors like us paying more attention to China's A-shares. After all, international investors do not yet have a great impact on the market. It seems to show, however, that local investors are taking a cue from non-domestic investors when it comes to picking A-shares. If this trend continues, we might see fundamentally driven stocks outperforming story-driven ones in a market that has traditionally been dominated by relatively volatile retail flows.
The A-share market can be full of surprises: Many investors perceive A-share companies to have poor corporate governance, but we have observed an encouraging improvement in the Chinese leadership's attitude toward capital allocation in recent years. It is no longer about more capital, but about ensuring that capital goes to the right places.
People are always astonished to learn that in terms of market transparency and disclosure, Chinese mainland companies have better data disclosure than companies in Hong Kong. But while the framework for better market disclosure is in place, the willingness to share profit growth with minority shareholders has been somewhat lacking. When it comes to dividends, a lot of companies pay just a token dividend without any substance. Compared with the broader Asia market, China's A-share market companies tend to offer below market-average dividends, and the average payout ratio is still quite low. Now we are seeing early signs of change.
Even before the inclusion into the MSCI indices, Chinese regulators realized that it is not possible to have healthy market with an investor base that has a trading mentality. One way to attract longer term investors is by encouraging companies to improve their corporate governance.
The Chinese government encourages banks to lend to private enterprises and offers companies incentives to pay higher dividends. The stock exchange, for example, has issued guidance that companies which regularly make dividend payments will find it easier to tap capital markets. Such top-down governance changes are increasingly being reflected in better capital allocation by listed companies.
In our dividend-based strategies, we use dividends as a lens through which we seek to identify high-quality, financially healthy companies with prudent capital allocation policies. We look for companies that offer meaningful dividend yields, with sustainable business models and that demonstrate the propensity to pay increasing dividends over time. Only companies with strong financials that include solid balance sheets, low financial leverage, and improving cash flows and dividend payout ratios are considered.
So do we consider China's A-share companies as the next dividend opportunity? I would say that we are excited by the expansion of the investible universe of dividend-paying companies. We are encouraged by the trend of China's market liberalization efforts and reform measures. As China's A-share market evolves to become increasingly driven by company fundamentals, we believe that our investment approach is well-poised to tap into compelling investment opportunities.
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