How I turbocharge 9.5% yielding portfolio

Sat Duhra of Henderson Far East Income explains how call options help enhance the investment trust’s income offering, the Asian countries he’s feeling bullish and bearish about, and the portfolio’s exposure to AI and tech stocks.

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Dave Baxter, senior fund content specialist at interactive investor: Hello and a very warm welcome back to our Insider Interviews series. I’m Dave Baxter here at ii and today our guest is Sat Duhra, portfolio manager on Henderson Far East Income Ord (LSE:HFEL) Investment Trust. Sat, many thanks for joining today. 

Sat Duhra, portfolio manager of Henderson Far East Income: Thank you.

Dave Baxter: So, many people are familiar with the fund, but for those who don’t know it, what makes it stand out? What makes it distinctive? 

Sat Duhra: So, Henderson Far East Income is an income fund investing in the Asia-Pacific region, and the objective is quite straightforward. It’s to grow the dividend per share every year and alongside that see capital returns from our region.

The thing that sets it apart is not only the high yield. Obviously we have a very high yield, we’ve sustained that for a number of years, but it’s actually alongside that seeking some of the best structural growth themes in the region. 

So, when we think about things such as technology supply chains, infrastructure, and financial inclusion, we want to be exposed to those great structural growth themes because Asia after all is the fastest-growing region globally. So, doing that alongside each other is really the redeeming feature of this. 

Dave Baxter: You mentioned that high yield. I think the last time I checked, it was somewhere around the 9.5% territory. It tends to be the highest-yielding equity trust out there. Which stocks and sectors are feeding into that yield? 

Sat Duhra: In some ways the answer is obvious. There’s a number of sectors that you would expect to be high yield, so utilities, telecommunications, financials. These are all really high-yield sectors in our region. That’s something that’s not very well understood, that in our region we can buy stocks that are 5%, 6%, 7%, 8%, 9% yield stocks in those sectors. And those sectors are actually growing as well. 

So, the financials, for example, through wealth management, opening new branches and so on, are growing very fast. And then utilities are doing really well, infrastructure has been built out, that kind of thing. So, these are stocks with high yield, but also good growth.

Now, alongside that, we have a number of very exciting growth stories, mainly in the technology space. They don’t really have much of a yield at this point, partly because performance has been so strong in recent years. There we use an option overlay. So, we write options on the more volatile part of the portfolio, predominantly technology stocks at this point. That will generate a huge amount of premium at this point. The level of volatility is just increasing. So, the premium being generated is really high at this point. In fact, some of the highest levels we’ve ever seen. So, it’s balancing those two things, using the option strategy to get growth exposure, but having a core of very defensive, high-quality names in there as well. 

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Dave Baxter: This is always a big ask, but for those who don’t know about them, can you explain in layman’s terms what the options overlay is and what you’re doing with the other side of that trade? 

Sat Duhra: Yeah, sure. Generally, we write calls, and so it’s a call overwriting strategy. What that means is that when we have a stock that’s performed quite well and we think it’s reaching our target price, we can do a couple of things. We can sell the position, we could reduce it, or we can write a call option on that particular position. 

Now, when that stock reaches a strike price, which normally we set out three months ahead, then effectively we will lose the position beyond that level. However, we get on day one, the premium, and that premium can be quite high, maybe 3% or 4%. It can currently be maybe 7%, 8% or 9%. Those are some of the levels we’re seeing now.

So, you get the premium, and that’s income for us. However, you can keep the stock, enjoy the upside, but if it goes beyond the strike price, then you give up that position. 

Now, I think something people would say is, well, then you’re going to lose your best-performing stocks. Well, we only do it on a small part of that position. So, we maybe do a fifth of that position and as it moves out, we maybe do a bit more, so we don’t expose the whole position to that, so we don’t lose a position completely.

It’s quite a generally well accepted way of creating income for income funds nowadays. And it’s gained more and more popularity as the years have gone on. So, call overwriting has become quite a nice way of enhancing income for income funds. 

Dave Baxter: To simplify, I guess it’s boosting your income, but it is limiting the potential gains you can make on certain bits of the portfolio. I did want to return to the point about the high level of yield. Are there a few examples of stocks that are offering those really interesting yields at the minute? 

Sat Duhra: One thing that really stands out when we’re talking about these great themes is, for example, Singapore banks. These banks have performed really well in recent times, but also in the last year they’ve done a really good job.

What they’re doing is taking advantage of this huge deposit flow into Singapore. So, wealth management is a really strong driver of performance for those names. Alongside that, they’re doing buybacks, they’re increasing dividends, they have strong capital positions and they have pretty steady margins and low credit call. I mean, they pretty much tick all the boxes.

While that’s going on, Singapore is attracting a lot of funds. The government and regulators are trying to encourage more investment into that market. So, that money has gone into some of the banks as well. There’s a sector that pays high yield. Some of them pay 4%, 5% or 6% yield, but they also have a great structural theme behind that, which is all about financial inclusion, wealth management, insurance products and so on. So that’s performing very strongly at this point. 

Dave Baxter: You do have decent exposure to some of those exciting growth stocks that actually have pretty low dividend yields, so think names like MediaTek, SK hynix Inc ADR (NASDAQ:SKHY), and Taiwan Semiconductor Manufacturing Co Ltd ADR (NYSE:TSM). Given that, how do you balance the income and the growth considerations in the fund? 

Sat Duhra: Yeah, that’s a very relevant question for what we do because at the end of 2023, we repositioned the portfolio. I took over the management of the fund as the lead manager at that point, and we decided that we had too much invested in deep value cyclical names, which optically looked great because they were on very low price/earnings (PEs) and had very high yields, but they were essentially value traps.

This is where we really changed the way we managed this. We then moved into areas such as technology and we also moved into India. We moved to a number of areas where there was real growth for years ahead in those particular sectors and markets. That was a key thing, balancing that capital growth alongside the income.

So, we didn’t sacrifice the income of the portfolio, and you can see over the last couple of years that we have still increased the dividend per share (DPS) year on year. In fact, we’re getting on to 19 years consecutive DPS increases.

But alongside that, you’ve also seen that the share price has been moving up. We’ve been tracking the benchmark on the way up, and the reason we’ve achieved that really is through a lot of these technology names. So, if we had not done that, we would have really been pretty stable. So, that helped us to move the share price higher because net asset value (NAV) was moving up, and that’s really through these kind of names.

Now, the option strategy allows us to do that. It allows us to buy those names and generate income on that. Some of those names you’ve mentioned, MediaTek, TSMC, we do write options on all these names. So, we get the upside, but we also get income as well. So, it’s balancing those two things.

When we’re more positive on growth names, we can add a bit more to that, use the option strategy more, and when we want to turn more defensive, we can take that down and add more to the Singapore banks, the utilities and those kinds of things, and manage those two parts of the portfolio. 

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Dave Baxter: In the last year or so, Asian shares have rallied really aggressively on the back of this big AI excitement. What’s your outlook there and how are you navigating that situation? 

Sat Duhra: We do have some meaningful exposure to the AI theme. Again, as you’ve mentioned, those technology names, Hynix, MediaTek, TSMC, and so on, are all exposed to that. 

Now, if you think about when we bought those stocks, it was well before we got a lot of this hype around the AI story, it was some time back. 

When we brought these names, we were looking at valuation, we were look at potential for income growth. The DPS has been increasing on these names. But also the exposure to things such as autos, the semiconductors that are used in the auto industry, smartphones, PCs, those kinds of things. It was not just predicated on AI. 

So, the AI came along and obviously boosted the performance of these stocks and is a genuinely strong theme for these companies because while the US companies are investing heavily and you’re seeing they are raising debt, their free cash flows is turning, in some cases, negative, the beneficiaries of that profitability is all in Asia. So, the likes of Hynix and Samsung Electronics Co Ltd DR (LSE:SMSN) are going to be some of the most profitable companies in the world. The earnings have really exploded.

They’re actually not very expensive stocks because the earnings have kept pace with the move in the share price, or maybe the other way around. So, that’s something that makes these things so very attractive. We do like them, but we are managing that risk because there is, for example, a lot of leveraged exchange-traded funds (ETFs) in Korea, a lot of retail participation in these names, so you do have to be a bit careful in some of that. 

Our exposure is much broader. We like financials, we like infrastructure, we like technology, but we have a much broader base of exposure in terms of country and sector than maybe our peers and the index. 

Dave Baxter: Let’s drill down now into regions and countries. Where in Asia are you most bullish and where are you exercising a bit more caution? 

Sat Duhra: An easy way to answer is to look at North and South Asia, because North Asia traditionally has worked very well for us in terms of valuation, income generation,  growth and dividends, but also it is the beneficiary of technology. 

Those key technology players are in South Korea, they’re in Taiwan, they are in China, but a lot of the dividend growth is coming through in those areas as well. Hong Kong is doing really well in terms of providing dividends from property, telcos, that kind of thing. North Asia also has less policy risk and, to a degree, less currency risk compared to South Asia.

The problem with South Asia is that it is very much driven by the consumer. So, these are more consumption-led economies. You think about India, the Philippines, Indonesia, that kind of thing. Also their currency has been very poor. Part of that reason is that inflation has been, maybe not out of control, but certainly higher than we expected. That’s because fuel and food is a big part of their CPI-like basket. So, fuel prices have gone up, food prices have gone up, fertiliser prices have gone up, that kind of thing.

There’s also been some risk around government policy as well in the likes of Indonesia and India. So, those things have [meant] a lot of foreign outflow from investors, currency risk, government policy, inflation, and a weak consumer. 

We have less in South Asia for those reasons and a lot more in North Asia. North Asia has outperformed South Asia, too. So, we still don’t see a reason to change that balance. 

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Dave Baxter: Which specific countries in North Asia are you especially exposed to? 

Sat Duhra: Our biggest weights would be in order, Taiwan, South Korea, and China. It’s not that we are especially positive on the macro in those places. For example, in. China, we think there’s some real risks in terms of macro. However, the stock market doesn’t necessarily reflect the underlying economy in some cases.

If you think about India, for example, it’s a very narrow market if you take out Reliance Industries Ltd GDR - 144A (LSE:RIGD), you take out some of the private sector banks and the IT service names. There’s not that much else left there, but that’s not really the economy. 

The same in China, you see these big players like Tencent Holdings Ltd (SEHK:700), Alibaba Group Holding Ltd ADR (NYSE:BABA) and so on, but the real economy is more industrial and it’s less represented in the indices. So, there can be a mismatch in terms of the real economy and stock market indices. That means there’s a lot of opportunity in this market.

In China, we really like the high-yield state-owned enterprises, for example, they’re performing well. Some of the bank stocks have doubled since 2023, insurance companies and so on. You know they’re doing very well, they’re paying very high dividends.

One of our best performers in the last 12 to 18 months has been an aluminium company in China, which had an 11% yield and doubled over a year. These are companies that are being ignored by the market. So, we look for these kind of stocks. 

In Korea, obviously, we have the memory names that you mentioned. They are doing very well, and we have exposure to that. But there’s a whole raft of corporate reform that’s been very positive for a number of other sectors in Korea as well that have increased dividends. And Taiwan, we think there’s really good value technology now with the yield as well. So, there’s a lot of opportunities within that. 

Dave Baxter: And how are you feeling on India? You’ve mentioned some of the headwinds there. I guess also another interesting premise on India that I’ve seen thrown around slightly is the idea that maybe it doesn’t have any really obvious AI plays. So, it’s kind of missed out on some of this surge that we’ve already discussed. 

Sat Duhra: That’s certainly true because what we’ve seen in the past, as China’s done well, for example, money comes out of India to fund China positions. I think some of that’s going on now. Money has come out of India to fund Korea maybe and Taiwan.

But having said that, there’s been a lot of foreign outflow from Korea as well. India saw about $20 billion (£15 billion) outflow from foreigners last year, and it’s a very high number this year as well, so people don’t like that market at this point. It is partly to do with the AI story because that’s sucking money out of South Asia and it’s going into North Asia. So, some of that is going on. 

But India’s had its own issues. The macro is not great. Gross domestic product (GDP) growth has been pretty weak. Normal GDP has been coming off. And so even though the real GDP numbers look OK, it’s the GDP deflator that’s creating that number. So, I think there’s a little bit of a mismatch between what’s really going on, on the ground.

If you look at employment prospects, we look at FDI (foreign direct investment), we look at industrial production, none of these things look that great, and profitability... I mean, IT services, which is a big constituent of the Indian indices, has been really smashed by the AI story because there’s a real threat there, and so those stocks have done very poorly. 

Dave Baxter: Names like Infosys Ltd ADR (NYSE:INFY), that kind of thing?

Sat Duhra: And TCS and so on. I think there’s been a bit of a risk around that. We like some of the utility names. Maybe we’ll be looking at those, maybe that could be interesting for us, but at this point we have zero weight in India and it has certainly been beneficial from a performance point of view over the last 12 to 18 months. 

Dave Baxter: I’d be interested to know now how focused the portfolio is on the strong demographics in Asia and the idea of the enriched consumer. I suppose that used to be the real bedrock of Asia and emerging market investing, but it seems like it’s been a bit lost in the noise around AI as of late. 

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Sat Duhra: I have to say on the consumer, you’re right. In years gone by, it has been a very strong story for Asia, particularly in South Asia. In countries such as India and the Philippines, the consumer’s been very strong, and those consumer companies historically have performed very well. Even in Korea, for example, we talk about cosmetics and that kind of thing, the demand from China and so on. However, it’s just not working anymore.

One of the reasons is that many of these consumer companies are in South Asia, and what happened after Covid is that the household balance sheet just never got repaired. People went through a really tough time in South Asia in terms of their household balance sheet, and they are financially not as strong as they were. 

This is one of the reasons why consumers are still weak in South Asia. They haven’t had the support from the government. They are kind of in some of these markets, such as Thailand, Indonesia and India, getting cash handouts, but it’s not enough. So, the consumer is still under a lot of pressure and that means that the consumer stories just don’t have that momentum or the growth that they used to. 

As you say, the AI story has certainly crowded out the consumer names as well. People are saying, well, why would you stick around consumer names when some of these stocks are up 50%, 100% in a month? So, the money has flowed out of these names, but there is a fundamental weakness in the consumer in many of these markets. Therefore, we don’t think that particular sector is very attractive at this point. 

What we like is some of the names in China, for example. We have a company called Midea Group Co Ltd Ordinary Shares - Class H (SEHK:300), which people may recognise. If you go on to the Currys (LSE:CURY) website, you might see washing machines and fridges made by Midea. They also do air conditioning units [which] have been flying off the shelf. But it also has a robotics business, which they might list. That company is doing very well. It’s also giving great dividends. 

So, those kinds of brands in China that are going international, obviously we’ve seen that with electric vehicle (EV) brands, but that’s a nice area to be in rather than South Asia consumers. 

Dave Baxter: Well, Sat, thank you for your time. 

Sat Duhra: Thank you. 

Dave Baxter: And thank you for watching. As ever, do let us know what you think in the comments. And if you’re a big fan of this series, hit the like button and the subscribe button. Thanks and take care.