Global equities: look before you leap

Janine Mace outlines the key factors investors must take into consideration before jumping back on the global equities train.

With the prospects for global shares looking a lot rosier now the global economy is in recovery mode, there are several key questions for Australian investors keen to seize the opportunity.

Although investing in an international exchange traded fund (ETF) is becoming a popular approach, many international equities managers believe the post-global financial crisis (GFC) investment environment means a passive approach is not the right way to go.

In fact, current conditions make it a stockpicker’s paradise, according to Principal Global Investors (Australia) chief executive Grant Forster.

“The correlation is reducing between different markets and stocks, so there is a growing opportunity to differentiate between countries. In this environment, the fundamentals and stockpicking are increasingly important,” he says.

While international ETFs and other new investment products are a good way to encourage Australian investors offshore, Forster believes financial advisers need to understand the best returns will not necessarily come from simply investing in an international index such as the MSCI World.

“There will be more opportunities to differentiate between markets and stocks going forward, making this more important than taking a passive approach,” he says.

The latest International Equities Sector Report published by Standard & Poor’s Fund Services reinforces this view, finding international equity managers managing less benchmark-constrained mandates “have been able to take advantage of opportunities around the globe and retract positions still exposed to the effects of the financial crisis. However, managers offering more benchmark-constrained international equity funds have not fared so well.”

Changing profit sources

The need to pick individual companies rather than simply investing in the index is further emphasised by the changing nature of many international companies and their reduced reliance on their home market.

The performance of many multinationals is now more closely linked to global growth and picking the right companies will be even more important, according to UK-based head of global equities for Threadneedle, Jeremy Podger.

“From a company point of view, the international situation matters increasingly to profit. Companies are making so much more money overseas now. The global economy is growing four per cent per annum, so companies which are addressing global growth are having a good time of it,” he says.

Fidelity Investment Management (Australia) investment commentator, Michael Collins, agrees this is a key issue for Australian advisers and investors to consider.

“Financial planners need to realise for Europe and the US, big companies are not stuck in their home markets and they are also benefiting from the rise of Asian consumers. A recent Citigroup study found 25 per cent of all sales by European companies are from emerging markets. This is why stock markets are capable of growing faster than the home economy,” he explains.

“Of the top 10 stocks in the MSCI World Index, Apple gets 49 per cent of its sales outside the Americas. Microsoft gets 52 per cent of sales outside the US, Nestlé gains 77 per cent outside Europe and even GE has 54 per cent of its sales ex the US.”

This is a key message for local investors, according to Collins. “Investors need to pick the companies that give the best results.”

He cites Chinese consumers’ love affair with luxury brands like Louis Vuitton. “The returns that a company like that can achieve in the next 10-15 years are significant in rapidly growing Asian markets.”

Going hedged or unhedged?

Financial advisers also need to consider the strong appreciation of the Australian dollar when it comes to investing offshore.

Over the past 12 months, investment returns in Australian dollar terms have been reduced as the currency has moved upwards, according to Credit Suisse Private Banking head of Australia research, David McDonald.

“Offshore investment returns have not been as good, due to the Australian dollar appreciation,” he says.

Bloomberg data shows the Australian dollar was up 14 per cent in 2010 against the US dollar and in the first four months of 2011 it rose 7.2 per cent – the biggest appreciation among all the major Asian currencies.

Forster agrees currency movements are an important issue for planners to factor into clients’ investment plans.

“Hedged and unhedged returns are very different at the moment. For the first time in many years it has paid to be in hedged international stocks,” he explains.

Over the five years to the end of April, international hedged funds have returned 1.7 per cent, while international unhedged funds have returned -1.5 per cent, according to Forster. “So it has not been a good time to be unhedged if you are an Australian investor.”

Looking ahead, he believes advisers need to think through the likely scenarios. “Growth is not about to fall off a cliff, so the Australian dollar will not fall too much. However, planners could consider using a mix of unhedged and hedged funds.”

Although local investors may have been disappointed by the impact of the appreciating dollar on returns, market experts believe there are benefits from strong currency.

“People should see the high Australian dollar as an opportunity, as it means they are able to buy offshore companies cheaper and hedge their investments,” McDonald says.

Collins agrees a strong dollar has important benefits. “With a high Australian dollar you are getting more from your money, but too many investors focus on the reduced return.”

Local investors stay put

Despite the benefits from offshore investments, many local investors still appear unwilling to brave international markets.

“We have seen a lot of talk but not a lot of flows. The high rates for cash deposits in the Australian market make it hard, compared to the situation for US investors where they get almost nothing,” Forster explains.

He believes this will change as inflation creeps up in Australia and real returns decline. “The underperformance of term deposits compared to markets will be increasingly important in the years ahead.”

Podger is a little more upbeat. “People stuck with what they knew in the GFC, but now they are moving to go overseas again.”

Collins agrees: “We have seen a bit of an increase in interest in international equities. We have seen some interest in China and Asia, but Australian investors tend to still be interested in the last big thing, and that is Australia.”

However, McDonald believes the improved access to international markets through ETFs and specialist regional funds will help. “The availability of new global investment products helps a lot and ETFs make it easier for Australian investors to gain access. The publicity for them has helped too.”

Despite this, Podger feels the volatility of the local currency will keep many investors at home. “Australian investors are conditioned to expect an ever-strengthening Australian dollar and that makes home country bias more of an issue.”