Since bottoming at the end of October, the MSCI Emerging Market Index (MXEA) and MSCI Asia Ex-Japan ...
A Fund That Thrives on Chaos
02/23/2011 12:33 pm EST
A focus on high dividends and writing covered calls has turned this fund into a cash cow, writes Paul Tracy in High-Yield International.
ING Asia Pacific High Dividend (NYSE: IAE) is a closed-end fund that invests in a diversified portfolio of between 90 and 170 dividend-paying companies based in the Asia-Pacific region. In addition to collecting dividends from these companies, ING enhances its income potential using a strategy known as covered calls.
Covered calls allow investors to collect a series of call premiums over time, effectively generating income from their portfolio holdings.
ING Asia Pacific fund sells calls against individual stocks in its portfolio as well as calls written against major Asia Pacific stocks indexes and exchange-traded funds. In total, the underlying value of calls sold represents up to half of the total portfolio value.
In 2010, ING paid out a total of $1.73 via quarterly distributions, equivalent to a yield of roughly 9.3%. The average yield on stocks in ING's portfolio is around 3.8%, less than half of the yield on the fund itself. The major reason for that discrepancy is that in addition to dividend income, the fund is receiving considerable income from selling covered calls on stocks in its portfolio over time.
Bring on the Volatility
As a rule of thumb, covered call strategies tend to generate the most income in more volatile market environments because market volatility inflates the values of call options. That means that the amount of income ING can receive from selling calls will vary significantly from year to year, and investors can expect some swings in the amount of distributions paid over time.
While selling covered calls provides income, there's a trade-off. Selling a call limits your upside in the underlying stock. If you sell a call against a stock and that stock rises above the call's strike at expiration, the stock will be called away from you and you will be paid the strike price of the call for your stock. That means that you won't benefit from any upside in the stock above the strike. That's why covered call strategies can underperform during strong markets.
However, the fund has generally performed well, returning more than 90% in 2009, one of the most volatile years for Asian stocks in recent memory. The fund's benchmark, the MSCI Asia excluding Japan index, returned 72.1% in 2009. In 2010, ING underperformed its benchmark, returning 13.6% compared with 19.6% for MSCI.
Economic growth in Asia remains strong and dividend growth has been picking up. Meanwhile, market volatility has made a comeback since the start of the year, due in part to investors' worries about the potential for inflation to accelerate in countries like China and India.
Asian Growth on Track
Ultimately, Asian stocks are likely to perform well this year as they remain the world's best growth story, and ING's portfolio is well-positioned to profit. The fund's largest single country weighting is Australia, worth more than one-quarter of the portfolio. The Australian economy avoided the worst of the 2008-09 downturn and benefits from a healthy banking system, strong leverage to key basic commodities, and pristine public finances. In 2011, look for capital spending on new mining projects to act as an engine of growth.
With roughly equal weightings, China, Hong Kong, and South Korea account for a further 40% of the fund's total assets. China and Hong Kong are both obvious beneficiaries of growth in the region's fastest growing major economy—mainland China. South Korea is benefiting from strong demand for its exports.
Top holdings include mining giant BHP Billiton (NYSE: BHP) and Westpac (NYSE: WBK), an Australian bank. The fund also has significant exposure to Asian technology plays, including Korea's Samsung Electronics (Seoul: 005930) and Taiwan Semiconductor (NYSE: TSM).
The stocks in ING have an average price/earnings ratio of 15.6, roughly in line with the S&P 500's trailing P/E. But investors are typically willing to pay larger earnings multiples for stocks with superior growth potential. ING is leveraged to a host of fast-growing Asian economies, while the S&P 500 has more exposure to the mature and slower-growing US market.
On that basis, ING looks like a bargain. The fund is a solid high-yield play on emerging markets with moderate risk.
[Prieur Du Plessis and David Fuller doubt that inflation will sidetrack Asia’s emerging economies. Russel Kinnel recently recommended a top Asian fund to take advantage of the region’s superior growth.—Editor]
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