International equities to take the lead

With domestic equities and listed property having been the key drivers of Australian superannuation fund returns over the past 18 months, there have been plenty of suggestions international equities will emerge as the key driver in 2005-06.

The only problem with this hypothesis is that while international equities have shown moments of promise over the past eight months, they have not looked likely to supplant other asset classes as the key driver for superannuation fund returns.

The relative performance of international equities over recent months has been highlighted by InTech Investment Consultant’s data, which makes clear that they have struggled in comparison with domestic equities and listed property, particularly where exchange rates are concerned.

However, InTech’s more recent data suggests that international equities may yet make a more significant contribution to returns, having posted 3.8 per cent in July, albeit it on the basis of a very flat Australian dollar.

The result of this is that many superannuation fund executives have not significantly increased their allocations towards international equities but, rather, have sought to retain the services of managers who they believe can deliver better alpha.

However, as IXIS Asset Management Australia managing director Karyn West makes clear, Australian investors have little option but to look offshore for growth.

She points out that while Australian equities may have been the primary driver for superannuation fund returns over the past 18 months, the Australian market represents a relatively small proportion, only 2.3 per cent of the global equity markets as represented by the MSCI World Index.

Furthermore, she points out that three-quarters of this weight is in the 25 largest Australian companies, of which only 10 have growth rates above 10 per cent, and almost half of these 10 companies are involved in the materials and energy sectors, where commodity prices have pushed growth rates above historical levels.

“The point of these statistics is that it is quite difficult to build a diversified, growth-oriented portfolio with meaningful capacity solely using Australian stocks,” West said.

“Expanding the investment mandate to a global portfolio of growth-oriented stocks offers far greater flexibility and return potential, as the manager can choose from hundreds of stocks across the rest of the 97.7 per cent of the global equity markets.”

Not surprisingly, West said IXIS believed that, in terms of growth versus value, “the economies are slowing, and growth companies will navigate through the morass in a better fashion”.

West’s view with respect to growth versus value in international equities is backed by the most recent Merrill Lynch research out of the US, which argues that growth stocks are scarcer than most investors believe.

“Right now, a lower proportion of companies are increasing their earnings by more than 10 per cent than at any time in the past 14 years,” the Merrill Lynch analysis said. “That ‘scarcity’ has occurred in recent months, and it is the primary catalyst for a rotation from value to growth.”

Discussing the prospects for international equities over the next 12 months, the managing director of HFA Asset Management Spencer Young said that investors were best-advised to remain well diversified in terms of their asset allocations.

“The bottom line is that you can’t pick the market,” he said. “Something always comes along to confound your choice, whether it be a war in Iraq or higher international oil prices.”

“It is not a question of saying this or that, it is a question of how much of this or that,” Young said.

“What investors are looking for is consistency from an investment portfolio, and that is something they tend to get from good advisers who look at asset allocations within a well-diversified portfolio, rather than trying to pick the market,” he said.