The natural tendency when considering the prospects for a global equity portfolio is with reference to the S&P 500 or the US market. Daily updates on the ups and downs of a largely irrelevant index known as the Dow Jones reinforces this.
Few tell you how much the Stoxx 600 has moved or what the emerging market indices did overnight. Even the once-mighty Nikkei rarely rates a mention. There is, of course, some logic in this, given the high weighting of US stocks in global indexes.
Savvy investors, however, know there are more meaningful benchmarks, such as the MSCI World or MSCI All Country (ACWI).
The MSCI World consists of 23 developed markets, with the US representing 57 per cent of the index. The ACWI includes a further 23 emerging markets, with the US weight consequently down to 52 per cent. Australian investors can access either of these through ETFs at a cost of between 14 and 21 basis points a year.
In the past few years, the S&P 500 has outperformed most other markets. US stocks have benefited from early and aggressive monetary intervention, and the robust corporate credit market has served well as an alternative source of capital. Structurally, the relatively high weight in information technology and healthcare stocks – the star sectors – has helped, and the persistent level of stock buybacks has added some 2 per cent a year to EPS growth.
With valuations in the US above historic averages and the impact of a rising rate cycle worrying investors, there has been a shift in funds towards Europe and emerging markets.
Europe has, in fact, been the best-performing index in the past quarter. Emerging markets are inevitably a mixed bag, but there has been support for countries such as India, Indonesia and Mexico.
So what is an investor in Australia to make of this? For those with active fund managers that are global benchmark-unaware, nothing. Your fund manager is paid to make that decision.
It is much easier for an Australian investor to make a specific allocation to emerging markets or Asian markets than Europe or the US, due to the large numbers of active fund managers in emerging markets.
For those inclined to pick regional markets, being clear on the reasons why, rather than following a fashion, can be the challenge. In our view, ETFs are the better option to tilt a portfolio within developed markets.
Right now, the bias in developed markets is not obvious. While the US is facing a rising rate cycle and high valuations, other developed markets are not exactly trading at bargain prices any more.
Europe may see support persist as its quantitative easing gets under way, and the lower euro adds to earnings, while in Japan a parallel pattern is unfolding. However, in our view it will be sector and stock-specific calls that are important, suggesting that active strategies will have the upper hand for the time being.
Sectors matter more than ever as the globalisation of many companies in developed markets means where they are domiciled (and listed) is inconsequential.
Emerging markets may only make up 10 per cent of the weight in the ACWI index, but that understates the size of these economies. For patient investors, the longer-term potential is appealing. It’s not for the faint-hearted, however, with external influences, imbalances and a tendency towards extreme over- and under-valuation.
Nonetheless, it is easier to make the case for an overweight position compared with the benchmark for those with appropriate time frames and the desire for capital growth.
By and large, ETFs are not as varied here as elsewhere, as the attractiveness of each country’s market can be highly variable.
Sector concentration in each market can also be high and result in exposure to themes unrelated to the main thesis.