A traveller departing from the spectacular Terminal 3 of Beijing’s Capital Airport would be shocked on arrival in New York at the crumbling infrastructure of JFK.
Chile’s fully funded state pension system is the envy of most governments in the developed world as they nervously eye their own pay-as-you-go pension time-bombs.
However, the prevailing view remains that investing in emerging markets is about tapping into the superior economic growth delivered by the demographic shifts of urbanisation, the wealth effects of a rising middle-class, or large-scale industrialisation supported by the cost advantages of cheaper labour.
But as the examples above show, these economies are increasingly mature, as are the companies operating within them. Given all of this, why should investors still be sceptical at the prospect of seeking dividend returns from emerging markets?
Of course the long-term drivers of growth remain important, and emerging economies are likely to outpace the rather feeble growth of their ‘developed’ neighbours for the foreseeable future.
But this focus on growth obscures the fact that one of the strongest trends for investors in these markets is a fast-developing dividend culture, something that it is unwise to ignore.
Growth and dividends are intertwined in emerging markets. As an investor, you do not have to forgo one to access the other. Simply put, stronger economic growth should translate to faster growth in corporate earnings, which with a stable dividend payout ratio, should see commensurate increases in dividends per share.
Companies in emerging markets frequently pay out a proportion of earnings rather than targeting a specific amount per share, so superior earnings growth is immediately reflected in the dividends. Statistical evidence shows there is a much stronger correlation between earnings growth and dividend growth in EM than DM.
This already attractive picture misses one of the most interesting aspects of the EM dividend story; that payout ratios are rising, largely because of improvements in corporate balance sheets.
Since the emerging markets crises in the late 1990s, company bosses have generally run their balance sheets fairly conservatively. Governments have mostly done the same – which is why I think the withdrawal of quantitative easing is unlikely to spark another EM crisis, although that is a subject for another article. The reasonable shape of company balance sheets in EM not only means that businesses are able to pay healthy dividends but that they are incentivised to do so, to avoid declining returns on equity.
Other factors are also encouraging the increase of payout ratios. As a relatively high proportion of EM-listed companies retain some degree of state ownership or control, increasing dividend payouts is one way of boosting cash-flows back to the government.
For example, Russia is pressuring companies to increase dividends to 35 per cent of earnings, while Brazilian corporation law requires a minimum ratio of 25 per cent. India, too, has asked state-owned companies to increase payouts.