It’s quite unusual for an Asia/Pacific fund to focus on dividends–in fact, yours is the only one of which I know. Why the unusual approach to the region?

Dividend investing is definitely an underappreciated art when it comes to Asia. A lot of the financial industry is still very much locked up into looking at the world through the old geography, completely missing the fact that this is a market that’s matured a lot over the last couple of decades.

If you go back to 2007, dividend payments for the MSCI Asia Pacific Index, which is a broad proxy, totaled $244 billion–pretty much on par with the S&P 500 and its $253 billion in payouts.

What’s even more important for long-term income investors is the growth of the underlying dividends, which provides additional income as well as a potential catalyst for share price appreciation. And if you look at the MSCI Asia Pacific Index over the five years prior to 2007, it grew about 24 percent annually–compared to about 10 percent for the S&P 500. Dividends per share (DPS) have grown much faster in Asia.

Normally, one would expect to pay up for higher growth in the form of a lower dividend yield. But the fact is, if you look at the historical data, Asian shares have tended to pay out a higher dividend yield than those in the US. Analyst estimates for the yield on the MSCI Asia Pacific Index sit at around 2.6 percent–3.2 percent excluding Japan–compared to 2.5 percent for the MSCI US Index. That combination of higher yield and higher growth makes Asia an attractive place for income-oriented investors.

Instead of looking for the growth in earnings per share (EPS), we focus on growth in DPS. Oftentimes the latter stems from EPS growth, but that slight difference makes quite a difference in terms of what we put in our portfolio.

We’ve seen a rash of dividend cuts here in the US. Have Asian dividends proved stickier?

Asia hasn’t suffered as spectacularly as the US–another reason why investors shouldn’t just focus on the US when they think about income. We saw companies that had been dividend paying stalwarts for many years–including General Electric (NYSE: GE), J.P. Morgan Chase (NYSE: JPM) and Pfizer (NYSE: PFE)–trim their dividends substantially. That came as a surprise to some investors who had grown accustomed to receiving these hefty dividend payments like clockwork.

Dividend cuts are also occurring in Asia; analysts estimate about a 15 percent cut across the board. Much of that has been concentrated among the cyclical materials and energy sectors, though exporters have also been hit hard. The financial sector hasn’t been immune, either. That said, you can still find companies focused on growing their dividends. In short, it’s a mixed picture: Some companies in our portfolio have reduced their dividends, but roughly an equal number have increased their dividends.

When we sit down and talk to the management teams at companies in which we’re considering investing, we make sure that we understand their dividend policy. We favor companies that don’t make decisions based solely on the payout ratio–still an important component–but also understand the importance of maintaining a dividend during a tough period. From our perspective, the absolute amount paid out is a crucial factor; if the company’s earnings disappear and management cuts the dividend, there’s less benefit to holding that dividend paying stock.

At Matthews Asia, we tend to focus on the growing household wealth and income levels in Asia and companies that cater to the expansion of the domestic economy. For the most part, exporters tend not to be a large component of our portfolios, if they’re represented at all. That’s one way to avoid the companies that would be under the most pressure to cut their dividends. Companies that have low payout ratios are also a good buffer. We invest in companies at either end of the spectrum: Those that have a low payout ratio but a more volatile income stream, or those that have a high payout ratio but operate a very stable and ongoing business–telecoms, for example.

Are there any specific sectors where you’re finding opportunities?

This has been a very volatile year so far. In the first part of the year we saw a selloff, then the markets snapped back very quickly–the MSCI Asia Ex-Japan Index is up 50 percent or so from the bottom in March. We focus on finding growth companies that have the potential to increase their dividends. For a while the market was rife with opportunity because these companies were trading at low valuations; now that the market has rebounded soundly, that window of opportunity has shut a bit. That’s why I’m focusing on the telecom and health care sectors, though my definition of the latter is relatively broad.

One of our top holdings is Top Glove (Kuala Lumpur: TOPG), the world’s largest manufacturer of latex gloves. A little more than a third of its revenue stream is now tied to emerging economies where there’s still a need for basic hygiene. Obviously, latex gloves are a very important part of that, and that’s why the company has seen very strong growth throughout this economic downturn. The stock has also become somewhat of a proxy for a spike in concerns about a large-scale outbreak of influenza or any other disease.  That’s the kind of health awareness to which we’re trying to gain exposure.

At around 2 percent, the stock’s dividend yield isn’t particularly high. But the DPS has been growing around 25 percent annually over the past three years. I’ve met with management and looked into the eyes of the Chairman and CEO; he’s a very dedicated individual, and I feel very strongly that he’s a person who will stick to his guns when it comes to that dividend payment. That’s the kind of on-the-ground, bottom-up research that enables us to take a position in a company that, on paper, isn’t a high yielding company.

With the telecoms, in developed markets like South Korea or Taiwan, we look at the stability of the cash flow behind the dividend. In markets like Indonesia and the Philippines, we also focus on the company’s growth potential. In Indonesia, PT Telekomunikasi Indonesia (NYSE: TLK) is by far the dominant carrier. But the business still has plenty of room to grow in terms of penetration. Despite its growth prospects and strong balance sheet, the stock boasts a dividend yield in the mid-single digits. This investment reflects my tendency to favor companies that have strong market positions.

Our No. 1 holding, Taiwan Semiconductor Semiconductor Manufacturing (NYSE: TSM), operates in a cyclical business but has close to a 50 percent market share. It’s a strong performer in an industry that’s very expensive in terms of capital expenditures and research and development. In that type of industry, it pays to invest in the leader; it’s tough to be in second or third place and always playing catch up. Taiwan
Semiconductor spends about $2 billion annually to maintain and upgrade their current production base. Not many companies can afford that kind of outlay, underscoring the firm’s strength. From my perspective, that dominance makes any near-term volatility easier to stomach.

What’s your best piece of advice for investors over the next year?

I wouldn’t invest in Asia unless you’re in for the long term. Although I’m bullish on Asia’s prospects, investors should remember that economic development doesn’t happen overnight. Much of this growth and development will take place over decades, not the next quarter or year. That’s very important to keep in mind; as we saw last year, short-term volatility is very much a part of investing in Asia.

Income investing is trickier these days; maybe it’s time to look abroad.