Optimistic on High Dividend Stocks in Hong Kong

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In recent discussions surrounding investment strategies, particularly in the context of the Hong Kong stock market, there's a growing interest in high-dividend stocksFor ordinary investors, this opens up an advantageous opportunity—not just to chase individual stocks but to consider investing in dividend index funds that effectively bundle a selection of these high-yield optionsThis not only simplifies the investment process but also spreads the risk among a collective of robust dividend-paying companies.

Recently, I attended a private conference organized by a hedge fund, where several fund managers shared their evolving strategiesMany focused on acquiring tech stocks in the American market, while others, contrastingly, highlighted the strength of Chinese high-dividend assets, particularly within the Hong Kong stock exchange

As I observed the differing viewpoints, I found myself aligning with the sentiment surrounding Hong Kong's dividend-paying stocks.

The Hong Kong stock market has been particularly hospitable to high-dividend paying equitiesThis trend is steadily attracting attention as investors seek relatively safer investments during periods of economic uncertaintyFor example, purchasing a dividend index fund could resemble acquiring a basket of high-dividend stocks without the need to perform extensive individual analysesThis could potentially yield a consistent stream of income for investors.

In my analysis of available options, I came across a specific index— the Hong Kong Stock Connect Central State-Owned Enterprises Dividend Index (931233)—which stands out due to its consistent yield and underlying stability offered by its constituents, most of whom are state-owned enterprises known for robust cash flow and dividend reliability.

Historically, dividend funds have significantly outperformed broader market indices

Typically, dividend funds focus on a defined group of stocks that showcase high dividend yields and a history of substantial cash distributionsExamination of historical performance reveals that irrespective of whether one analyses mature developed markets or emerging capital markets, dividend funds consistently exhibit commendable returns.

Take, for instance, the S&P 500 Dividend Aristocrats, a benchmark for dividend growth strategy in the US marketThis index specifically targets companies that have increased their dividend payouts annually for a minimum of 25 yearsNotably, data indicates that over the past couple of decades, the performance of the Dividend Aristocrats has largely surpassed that of the regular S&P 500 index, providing a compelling case for dividend-focused investment strategies.

Drawing parallels to domestic markets, we can closely monitor the performance of the Dividend Index in the context of Hong Kong equities

Comparing the Central State-Owned Enterprises Dividend Index with the CSI 300 Index over the past ten years reveals a notable trendAnalysis from September 2014 to September 2024 indicates that the cumulative increase of the Central SOEs Dividend Index has reached an impressive 95.34%, significantly eclipsing the 39.69% return observed from the CSI 300 Index.

This trend of outperformance is not isolated to just the Hong Kong marketA research report by Guotai Junan reviewed the period from 2009 to 2021, illustrating that during periods where the broader A-share market lacked vigor, the performance of Central State-Owned Enterprises Dividend Index often remained resilient, further emphasizing the anti-cyclical nature and defensive qualities of this investment category.

Speculation surrounding economic downturns amplifies the defensive attributes of central state-owned enterprises

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With the foundation of these organizations often rooted in monopolistic and essential sectors such as energy and utilities, their stability shines through in expanded cash flows and enhanced dividend capabilities—qualities that are increasingly valuable in a slowing economic climate.

For instance, China Mobile has committed to gradually increasing its cash distribution to over 75% of profit attributable to shareholders by 2024, while State Power Investment Corporation plans to raise its dividend payout ratio from 50% to 55% in the same timeframeThese pledges solidify the attractiveness of these investments for risk-averse investors.

Market trends continue to evolve, as illustrated by recent announcements from The People’s Bank of China which proposed innovative tools to encourage stock buybacks among listed companies as a method to stabilize market sentiment

This initiative could indirectly bolster the attractiveness of dividend-paying stocks, exactly when investors require the most assurance regarding their return on investment.

Additionally, a noteworthy differentiation exists between A-shares and H-shares, often highlighting that H-shares carry a higher dividend yieldWhen the same companies are listed in both mainland China and Hong Kong, H-shares frequently trade at a discount level of approximately 30%, thereby promising higher dividend yields compared to their A-share counterparts.

In liquidity considerations, while H-shares may not exhibit the same trading volumes as A-shares, for value-focused investors, it becomes evident that investing in lower-priced, higher-yielding H-shares remains financially advantageousFurthermore, the liquidity of these blue-chip stocks tends to be adequate for the pursuits of serious investors.

Reviewing the top ten components of the Central SOEs Dividend Index, we find that the majority are indeed leading state-owned enterprises, many of which are cross-listed as both A and H shares

This reinforces the notion that investing through these funds likely extends access to higher dividend yields, effectively creating an appealing financial proposition.

For instance, China Shenhua Energy currently has a dividend yield of 7.18% on its Hong Kong listing compared to 5.4% on its A-share listing, representing a 33% advantageChina Petroleum & Chemical Corporation displays even greater disparities, with the Hong Kong share yielding 8% against 5.2% in the mainland—a 54% differenceAgricultural Bank of China also presents a notable case with yields of 6.5% in Hong Kong versus 4.8% in the mainland—an advantage of 35%.

Even when accounting for the 20% withholding tax imposed on dividends from stocks traded through the Hong Kong Stock Connect, H-shares maintain a yield superiority over A-shares

This suggests that a long-term commitment to H-shares, especially those focusing on reinvesting dividends, could result in a substantially more significant accumulation of shares and dividend revenues over time.

Expectations of future changes to tax policies further bolster this investment rationaleDuring the national "Two Sessions" slated for 2024, discussions may pave the way for recommendations aimed at lowering dividend tax rates for individual investors within the Hong Kong Stock Connect and easing other entry prerequisites for mainland investors.

As it stands, mainland investors enjoy a waiver of the 20% withholding tax on cash dividends received from A-shares after holding them for over a yearHowever, investments through the Hong Kong Stock Connect could still incur withholding taxes of up to 28% for red-chip stocks

If mainland investors gain equal tax treatment comparable to A-shares for H-shares, a significant narrowing of the premium between A and H shares is to be anticipated.

Finally, when contemplating investments within dividend funds, the question of valuation arises—when to enter and when to exit becomes imperativeWhile traditional metrics such as price-to-earnings and price-to-book ratios typically inform stock evaluations, I advocate for a simpler approach when assessing dividend funds: tracking their dividend yield.

Given that the core selection criterion for these funds hinges on dividend yield, monitoring changes in this metric allows investors to pinpoint potential buy or sell signalsHistorical data suggests that the dividend yield for the Central SOEs Dividend Index has fluctuated between 3.51% and 8.89% over the last six years, with an average around 6.16%. With the current yield of the benchmark 10-year Treasury note hovering around 2.04%, this presents the dividend index as a special form of bond investment with slightly elevated potential returns, albeit with slightly looser guarantees compared to treasury securities.

As a rule of thumb, when the dividend index yield exceeds twice the treasury yield (greater than 5% in absolute terms), initiating a phased buying strategy is advisable to hedge against uncertainty