One of the biggest challenges facing financial planners today is what to say to investors about global equities. While modern portfolio theory suggests that global equities be around 25 per cent of a portfolio, many financial planners don’t know what to tell their clients after a lost decade of returns for most global funds.
The fact that Australia’s top 200 companies collectively earn around a third of their revenue from overseas suggests Australian investors are getting some exposure to the wider world when they invest in local equities.
However, having all your assets in one asset class, even Australian equities, is generally considered a risky investment strategy because if that asset class underperforms your wealth can plunge drastically. History shows that no country’s equity market performs well at all times. There have been plenty of time periods when international equities outshone Australian shares. Will the next few years be one?
There are compelling reasons why local investors should consider an adequate allocation to global equities. Global equities are around their lowest level in a decade and offer the opportunity for growth. There are some very good quality global stocks at reasonable values.
There are big differences between Australian and global markets. Australia’s top 10 stocks comprise around 55 per cent of the S&P/ASX 200 Index. The MSCI top 10 stocks only comprise 9 per cent of the MSCI World Index.
The top 100 stocks in the MSCI World only comprise about 40 per cent of the index. It takes about 150 stocks to reach 50 per cent of an index that covers 1650 stocks. So global equities are also far better diversified at a stock level.
Four of Australia’s top 10 stocks are financial companies and they along with insurance companies and listed property trusts account for 40 per cent of the index. Another quarter of the index is materials, the sector where mining companies and mining-services companies fit. So when you invest in local equities you are taking a sizable bet that financial companies and mining companies will do well.
The flipside to this is that interesting industries such as IT and healthcare are barely represented. So a focus on local equities means an investor is poorly diversified by industry.
Investing in global equities also offers better industry diversification. Investors can access industries that aren’t available on the local share market. These include industries such as car and airplane builders such as Toyota and Boeing, to smart phone makers such as HTC, to electronics companies such as Sony and Philips. Financials and material only comprise 28 per cent of the MSCI World index, not 65 per cent. IT is 10 per cent of the index, not 0.6 per cent. Fancy investing in Google or Ten Cent, China’s most used portal, for instance? Healthcare is around 10 per cent, not 3.3 per cent.
Investing in global equities enables investors to gain access to the world’s most successful companies including its icon brands. These and other global stocks have the potential to offer higher returns than local equities. Stocks in the MSCI World Index include companies whose products you probably use every day along with some other opportunities you might be aware of. These include diabetes play Novo Nordisk and Cisco Systems, which is an indirect beneficiary of the growth in data traffic resulting from the rapid take-up of smart phones, Citrix is a play on cloud computing, while Carlsberg is a play on increasing consumption of beer in Russia and Eastern Europe. Then there is Standard Chartered, which derives more than 90 per cent of its profits from Emerging Markets and Coca Cola which is expanding in Emerging Markets.
Another reason to invest in international equities is that they enable you to invest in developed countries that are at different points in the economic cycle than the local economy or in selected developing countries that are enjoying faster economic growth than ours because of where they are in their development. China, India and other emerging economies are expanding at three or four times faster than the local economy, which gives their companies vast scope to expand their earnings. This all adds to the diversification and potential returns of portfolios.
Didier Lenouvel is investment director, global equities, for Fidelity Investment Managers. Lenouvel recently addressed Fidelity Investor Forums around the country.
