Time to think and act global equities

Economic commentators point to the 1984 floating of the currency as the beginning of the end of Australia’s economic insularity.

With the increased importance of trade as a share of national income and widespread internationalisation of our economy over the past two decades, that year is rightly identified as a turning point in the country’s history.

It is somewhat surprising therefore that Australian investors have been reluctant to embrace international equities more fully.

At the end of 2006, superannuation funds with more than $50 million in assets devoted about a third of their portfolios to Australian equities, vastly exceeding the local bourse’s 2 per cent share of the global equity market.

I would argue that there are tactical and strategic reasons for Australian investors to lift their international equities weighting.

The tactical case stems from the power of mean reversion. After three successive calendar years of 20 per cent plus returns from Australian shares — well above the 9 per cent long-term average — the odds are that local market performance will migrate back nearer to trend levels over the next few years.

By comparison, returns from the MSCI World Index, which underperformed the S&P/ASX 300 Accumulation over the same period, may begin to look more attractive on a relative basis.

However, tactical investing in an effort to try to capture potentially higher returns from one market as another slows, is opportunistic. It is, in my view, more constructive to embrace the strategic rationale for going global.

On a risk-adjusted basis, investing globally is a superior proposition to massively overweighting the home market.

Our research shows that each of the local markets of Australia, the US, Canada, Japan and the UK, are more volatile than the MSCI World index.

The reason for this is structural: most obviously, there are far fewer stocks in the local market than in the world index and, thus, fewer ways to diversify risk.

After all, the MSCI World Index of more than 1,500 stocks is built by systematically including 80 per cent of the market capitalisation of each of the major developed countries in the world. By definition, no single country can offer anything close to the depth and breadth of the world as a whole.

Consequently, local equity markets tend to be more concentrated in a handful of large stocks than could ever be the case for the world.

The smaller the market, the more pronounced the stock concentration.

The 25 largest cap stocks have typically made up about 70 to 80 per cent of Australian market capitalisation.

By contrast, the largest 25 names typically make up only 20 to 25 per cent of the MSCI World Index.

Hence, Australian portfolios with an oversized domestic equity bias will naturally have greater leverage to the largest stocks — and more stock-specific risk — than those weighted more toward foreign equities.

Moreover, the Australian market is significantly concentrated in natural resources, financial services and listed property. The global index naturally diversifies these industry exposures.

Finally, going global provides a window to industries barely represented in Australia including information technology, consumer electronics, aircraft manufacturing and automotive makers.

Michael Bargholz is the chief executive of AllianceBernstein Australia and New Zealand.