Around the world

The diversification benefits and opportunities afforded by investment in global share markets are impossible to ignore.

A common mantra of managers is that global equities represent 98 per cent of all investment opportunities.
Global dividend growth has increased by 60 per cent since 2009 – reaching a sum of $1.167 trillion in 2014, according to the 2014 Henderson Global Dividend Index.

While in the recent past, articles on global equities have focused largely on why advisers should go global, many product providers and investment experts say the ball is now rolling and that Australian financial advisers – now more than ever – understand the value of global asset allocation.

Where, not why

The change in sentiment is attributed largely to Australia’s faltering macroeconomic backdrop.
As the economy navigates away from mining-based growth to more broad-based growth, the opportunities that once existed are now scarce.

“I think people are truly valuing the opportunity to diversify a portfolio into sectors and companies that they just can’t get on the ASX,” says Magellan general manager of distribution Frank Casarotti. “I don’t think I could name an adviser who is ignoring global equities, because it just seems too silly.”

Market Vectors’ director of investment and portfolio strategy, Russel Chesler, notes that the diversification benefits of global equities are well-established. “You diversify to minimise risk, but there are added diversification benefits in global equities,” he says.
“The Australian market is dominated by banks and resources; by investing overseas, investors can access companies and sectors that are not as prevalent [in Australia]. You not only get geographic diversification but you also get sector diversification.”

Meanwhile, Mark Vrkic, portfolio manager at BT-aligned Advance Asset Management, says we have reached a point in the global marketplace where there is a broadening out of opportunities.

“The world is not synchronised; that de-synchronisation creates different opportunities in different places,” he says.

Therefore, given that the case for global equities and the associated benefits has been well-prosecuted, this article will instead focus on the more pressing question for advisers: where, not why, to invest globally?

The fund managers and consultants canvassed by ifa were largely in agreement about which sectors provide the greatest opportunity and, as a result, the article will look at the macro and micro issues affecting the equity markets of Japan, China, India, the US and the eurozone that advisers and their clients need to be across.

EUROZONE
Macro: ‘Supercharged enthusiasm’

The announcement of quantitative easing (QE) by the European Central Bank (ECB) “supercharged” enthusiasm surrounding European equities, says Morten Springborg, Copenhagen-based portfolio manager with BNP Paribas firm Carnegie.

The QE program, and the US Federal Reserve’s ending of QE, has caused the euro to depreciate considerably in value.

“At the moment the depreciation of the euro has been excessive in the short term, so you’re probably going to be getting pretty decent currency adjusted returns in European equity markets for the next year on a relative basis,” Mr Springborg says.

The euro is now 15 per cent below its high of March last year, according to Credit Suisse. Unemployment decreased 11.3 per cent in February, down 0.5 percentage points over the past year, with economic confidence hitting its highest level since mid-2011, data provided in a Standard Life report indicates.

“The ECB’s monetary easing is also bearing fruit in terms of easier financial conditions for households and businesses alike,” the report said.

Micro: Exports and the euro

The European export sector is poised to benefit from a depreciating euro.

“The divergence in monetary policy, which we expect to continue, has resulted in a big boost to European exporters, particularly automakers and industrial companies,” says BlackRock’s chief investment strategist, Russ Koesterich.

This is an important consideration for investors, since 50 per cent of revenue for European large-cap companies comes from outside the eurozone, he explains. Any company with revenue in the US will benefit “tremendously” from what’s happening in Europe, Mr Springborg adds.

QE has resulted in increased liquidity, and so yields are depreciating to levels at which investors are not able to procure adequate return. As Mr Springborg points out, this trend provides investors with a “window of opportunity”. Asset gatherers are “hunting for yield” and entering asset management products at an elevated rate, he says. European asset management products are therefore a sector that Carnegie values highly.

This is an example of decent “pockets of growth” in an economy that is not really growing that fast, says Carnegie’s Mr Springborg. Financial advisers who understand market trends and where growth opportunities are derived from will undoubtedly benefit, he explains.

CHINA
Macro: A rapid opening up

The Chinese stock market is the second largest behind that of the US – valued at approximately US$ 6 (AU$7.66) trillion. Not surprisingly, the size of the Chinese market suggests that it should represent a sizeable proportion of an investor’s portfolio, says Market Vectors’ Mr Chesler. Moreover, reform is opening up the market and creating decent investment opportunities. According to an AllianceBernstein (AB) report entitled The Case for a Robust RMB Strengthens, the People’s Bank of China is aiming for full convertibility of the renminbi (RMB) during 2015. RMB internationalisation will provide opportunities for foreign investors in mainland China.

AllianceBernstein director of Asia-Pacific fixed income, Hayden Briscoe, says the central bank is also aiming for the inclusion of China in global bond and equity market indices. This will result in a flow of foreign capital into the Chinese market, energising various industries.

“Investment channels are opening up at a rapid pace, and the foreign investment quotas allowed by the government are expanding. If people haven’t already invested in China by now, we think they should consider it,” AB’s Stuart Rae says.

Micro: A-shares and small caps

With market liberalisation expected to continue, Market Vectors’ Russel Chesler believes that A-shares “will become an increasingly important destination for foreign investors”.

A-shares are dominated by large state-owned enterprises and are heavily concentrated in banking and financials.

“A-shares currently represent the largest portion of Chinese equities. [They] have historically provided differentiated performance from other equity asset classes,” Mr Chesler says.

The expected liberalisation will likely see the inclusion of A-shares in the MSCI’s global equity indices. AB portfolio manager of China equities, John Lin, also sees the potential in A-shares. “I think the onshore market offers great opportunities and a deeper way to penetrate, and to get real exposure in China,” he says.

The Chinese middle class is driving growth. The “rapidly urbanising population with incomes still growing at a rate in the low teens, who are now demanding more middle class consumption items, are going to be important drivers of economic growth in the future,” says Mr Rae.

According to Mr Lin, “Financial planners should pay attention to this rising growth segment. The opportunities will not be in just big cap financial and energy companies; often the smaller or medium sized companies which focus on making air conditioners or automobiles, or assembling smartphones, are going to be the most interesting from an investment perspective,” he says.

INDIA
Macro: Rewards of reform

Substantial structural and political reform places India in an ideal position for future growth. Reform is set to be implemented to eliminate approximately 15 to 20 per cent of bureaucratic deficiencies, says Saxo Capital Markets.
The firm’s investment outlook for Q2 2015 forecasts that India’s favourable demographics – more than 50 per cent of the population is under 25 years old – will fuel growth and productivity.

According to Nikko Asset Management’s head of Asian equity, Peter Sartori, the fall in oil prices has also been beneficial to the Indian economy. The drop has allowed the government to implement reform at a faster pace and begin to cut interest rates.

“So a market like India, we think, in 2015 could potentially cut interest rates by as much as 200 basis points and that will clearly be a big support for the stock market there,” he says.

The presence of India’s clear “agenda for reform” means investors should be optimistic toward Indian asset allocation, according to the Nikko global equity team.

Micro: Tech explosion

India’s demographics indicate that consumer-based sectors are favourable investment options. According to Mr Sartori, the technology sector, particularly smartphones, is experiencing “explosive growth”. Smartphones are being purchased by an emerging middle class – a class that has only recently been able to purchase such products.

This trend is important for investors to consider. Specifically, consumer-orientated sectors are buoyed by the emerging middle class and are therefore industries that will continue to grow, Mr Sartori explains.

“In general, it’s growth industries that we have a lot of confidence in – what their growth is going to be in the next five to 10 years,” he says.

Nikko’s global equity team added, “We would note, however, that India has performed strongly over the last 12 months and a degree of consolidation is likely as a result, though the long term story remains an optimistic one.”

UNITED STATES
Macro: Risky rates

“The US remains the key engine for growth in the global economy, driving the other developed markets,” says Credit Suisse in its Q2 2015 outlook report. Moreover, according to Credit Suisse, US equities remain attractive when compared with other asset classes.

“The US equity risk premium is 5.7 per cent versus its long-term average of 3.2 per cent,” the report says. “Approximately 65 per cent of US companies have a free cash flow yield above their respective corporate bond yield, supporting further corporate buying.”

Another trend to consider when allocating in the US is the possibility of a rate hike. In a Pimco report – Supply-Side Yellenomics Is (Slowly) Losing Its Grip on Markets – it is argued that the Federal Reserve “can no longer keep investors from pricing in an eventual rate hike”. According to Pimco, this is a trend investors can take advantage of.

Micro: Multinationals to watch

Author of the Pimco report, Tony Crescenzi, says investors need to realise that future rate hikes will be introduced slowly and be of low-magnitude. Nonetheless, investors will need to factor this into their investment strategy.
“In particular, the low interest rate environment will likely prevail for the rest of the decade compelling investors to continue to reach for higher yield and returns.
We suggest investors position themselves accordingly, favouring a bias toward overweighting credit and equity risk, taking advantage of opportunities to add both if anxieties creep into markets,” says Mr Crescenzi.

Regarding specific sectors, Magellan’s Frank Casarotti advises looking for a global business with a “multi-national flavour”. Domicile nationals with wide economic moats are increasingly attractive. Companies with diverse revenue sources, such as eBay, are competitive and provide value, he says.
Mr Casarotti says that when investing in the US, investors should identify where the potential is and subsequently identify the companies set to benefit from such potential.

“We think that the US housing recovery post-GFC will continue to be an above-average performer. The question is: how do you play to the sector and the sectoral theme?” he says.

However, Perpetual’s Garry Lawrence says that value is becoming harder to find. The potential of a rate rise may cause some volatility, but investors can still play to that, he says.

“US banks are a good way of playing rising rates because they benefit in their earnings as rates rise and interest rates rise.”

JAPAN
Macro: Abenomics earnings

As a result of aggressive economic reform, or ‘Abenomics’, the Japanese yen has begun depreciating. Quantitative and qualitative easing (QQE) implemented by the Bank of Japan (BOJ) has moved the economy from a deflationary state into inflation.

Nikko’s chief strategist, Naoki Kamiyama, says inflation is conducive to positive economic outcomes since it leads to productivity.
Corporate managers are subsequently more likely to hire people, pay more, and pay overtime, he says. This is an important trend currently being observed in the Japanese economy, he adds.

According to Mr Kamiyama, the most important reform policy that has been implemented relates to earnings power.

“What we are doing with this reform is focusing more on earnings and more about margin and efficiency in capital,” he says.

However, it is mid-term prospects for the Japanese economy towards which Mr Kamiyama is positive. Structural reform and fundamental improvements should take hold by March 2016, which will support the market.

Micro: Home and away

“Finally we have some signs of increasing export volume from Japan,” says Mr Kamiyama.

As with the eurozone, QE coupled with a higher US dollar has buoyed the export industry. With real demand outside Japan increasing, corporate earnings will be affected by climbing export volumes. The auto, technology and machinery industries are expected to benefit, according to Mr Kamiyama. The Japanese tourism industry is also benefiting from demographic trends such as the growing middle class of countries nearby.

“We have so much inbound demand from a tourism perspective,” he says, noting that this is helping two sides: “One is retail, department stores and electrical appliance type retailers. Also the higher sales volume is helping manufacturers.”

Closing the gap
Australian advisers are on-board when it comes to global asset allocation. Australian investors, however, remain conservative.

Legg Mason’s 2015 Global Investment Survey revealed that 77 per cent of Aussie investors regard themselves as conservative, while as a further point of concern, only 36 per cent intend to increase their exposure to international investment during the year.

Australians are well behind international investors – 67 per cent of the latter are looking to increase global asset allocation. As discussed earlier, the macro tailwinds needed to generate micro investment opportunities do exist.

Mr Casarotti argues that it is an adviser’s role to educate clients about the importance of investing in global equities.
“The average investing public are thirsty for information and are prepared to be educated and are prepared to read and view content,” he says. “Advisers play a critical role in helping investors: a) become more knowledgeable and b) become more willing to diversify a portfolio into things they might not be used to.

“At least in part, the adviser’s role is to help educate and to help diversify that portfolio away from purely Australian domicile assets.”

Mark Vrkic adds that advisers need to educate clients on the risks associated with global investment, not just the benefits. “The best thing for an adviser is to know the client well, to know what their objective is, and where their risk appetite lies,” he says.

Meanwhile, Perpetual’s global equities portfolio manager, Garry Lawrence, believes advisers need to spend more time with their clients to understand their level of comfort with global equities. If a client has poor confidence levels, an adviser should slowly introduce global equities to a portfolio, for example, he says.

It is now up to advisers to close the gap and help investors to develop the same enthusiasm for going global.