Bright future forecast for dividend products in Asia

Products based on the dividends of listed stocks were introduced in both Singapore and Hong Kong this week in a concept imported from Europe that looks set to gather steam in Asia.

Such products can allow conservative investors to tap low-risk returns generated from the dividend yields of stocks across a market, or enable more risk-tolerant players to bet on whether dividends will rise or fall, based on futures contracts.

In announcements this week, index provider FTSE created the Straits Times Index (STI) Dividend Index – which tracks dividends paid by stocks listed on the STI – in conjunction with the Singapore Exchange and Singapore Press Holdings, which constructs the 30-stock STI.

Hong Kong Exchanges and Clearing, meanwhile, introduced two sets of futures products based on dividend indices. Trading in the Hang Seng Index (HSI) Dividend Point Index Futures and the HSCEI Dividend Point Index Futures began on the Hong Kong stock exchange on November 1.

It comes after the HSI introduced those two dividend indices in July to track dividend payments of companies on the HSI and the Hang Seng China Enterprises Index, respectively.

As has already happened in Hong Kong, FTSE expects similar futures products and perhaps exchange traded funds (ETFs) to be based on its dividends index in Singapore, too.

“We have seen momentum in this space,” Jamie Perrett, the director of index research at FTSE, says. “It has very much been a European-based phenomenon, but we are seeing the interest growing in Asia.”

It seems likely that the most liquid exchanges in Asia will see the introduction of dividend-based indices before long, which have grown in popularity in Europe as the basis for futures products, ETFs, tracker funds and other structured products.

European investors have been able to trade dividend futures since mid-2008. FTSE introduced a dividend index based on the FTSE 100 in London in May last year, and the derivatives exchange NYSE Liffe then introduced futures based on the dividend index.

Similarly, in Italy, FTSE introduced a dividend index based on the FTSE MIB last November, and Borsa Italiana then rolled out futures based on the dividend index this April.

The concept first moved to Asia in Japan, which saw its first dividend index this summer.

A dividend index resets at the start of each year and then builds “value” as the companies in the underlying index pay dividends out. One of the attractions is that the dividend indices strip out any share price movements and simply track the cash dividend pay-outs made by the firms.

Products based on dividends will allow investment banks and fund managers that have created structured products based on underlying, dividend-yielding stocks to create products based on the dividends that they yield. That helps them to offload unwanted exposure to the dividends.

For an ETF that is tracking an index, for example, dividends are “white noise” that create tracking error away from index performance. The dividends produce cash that is temporarily out of the market when the dividend is issued.

So the push to create dividend-based products is coming from fund creators and managers. But the products themselves should appeal to a broad range of investors as they gain traction.

Creating a product that simply tracks the index can produce a conservative return equal to the dividend yield of the underlying firms. This can prove popular in times of market turmoil – in back-testing, the STI Dividend Index showed a gain of 4.05% for 2008, a year that saw the Straits Times Index plunge 47.3%.

Last year, however, the dividend index gained a tame 3.76%, compared with a 64.49% leap in the price index. This year, the Singapore dividend index is up 2.52% compared with a 8.46% gain for the Straits Times price index.

So a product based on the dividend index provides a steady return. Futures based on the index, however, can allow traders to hedge their exposure to dividends, or take leveraged positions based on how they believe dividends will perform.

“You don’t have the volatility of a price index,” notes Perrett. “It is a positive income stream that can be quite attractive. If you’re a trader you can take out the future to build your expectations of what the market is actually going to do.”

The exposure of derivatives based on dividend indices may be hard to measure. A dividend-tracking product is an index built on an index, after all. Adding a future on top of the dividend index adds another layer of complexity. But it seems demand for such instruments is rising from traders.

“It will be interesting to see whether other products are built on to the back of this,” Perrett adds.