Principal says that major developed economies have begun to show “many pro-cyclical attributes”.
“Economic strength was most visible in the United States and the larger more fiscally stable economies of Europe,” Principal says.
“Manufacturing activity and global trade remained particularly robust, with Purchasing Manager Indexes [PMIs] strongly in expansionary mode across most regions.
“Economic momentum also finally appears to be contributing to a modest upturn in the US employment situation. This adds confidence in the ability for the expansion to be self-sustaining. Corporate profitability also continues to remain very robust, as productivity gains have been among the best on record.
“A preponderance of earnings reports once again continued to exceed consensus expectations, despite tougher year-on-year comparisons in many industries following the near-record profit growth last year.”
Both Fidelity and Principal believe that in the current economic environment, a bottom-up approach to identifying offshore investment opportunities is likely to serve investors best.
“The view from a bottom-up stock selection perspective is quite constructive at present,” Principal says.
“Capital spending seems poised for further improvement, as do merger and acquisition activity and dividend payouts. Correlations among stocks have steadily trended lower in most market segments, creating a better environment for differentiation within sectors and regions.
“We remain committed to a strategy of choosing companies for our client portfolios that demonstrate a compelling combination of better earnings growth, margin expansion and positive earnings surprise … while simultaneously achieving those desirable attributes at valuation discounts.
“Historically, that combination of fundamental characteristics has corresponded to highly competitive results in subsequent periods.”
Lodha says his approach to portfolio construction is to “look for under-appreciated growth”.
“Ultimately, I am looking for companies which are expanding their profit margins and growing their cash-flows,” he says.
“I look for industry structures which offer attractive profit characteristics. For example, if an industry is becoming more consolidated, I would want to look for potential beneficiaries within that sector. I also consider M&A potential when comparing stocks.”
But Lodha urges investors to think outside the square when working out what themes or trends they want to capitalise on. He cites the rising level of car ownership in emerging markets as an attractive investment theme, but says it’s not necessary to invest directly in the emerging markets to cash in.
“One can invest in raw materials producers, such as the iron ore producers, the dry bulk carriers that transport the raw materials, the steel mills, the auto part manufacturers, the tyre makers, the distributors and so on,” he says.
In any case, Lodha says, in this scenario the dominant players in the manufacturing process are the iron ore and copper producers.
“Both materials are in short supply and are critical for the manufacture of a car,” he says. He notes that BHP Billiton and Rio Tinto have experienced strong growth from the increase in demand for raw materials from emerging markets, yet they are listed in the developed markets of the UK and Australia.
In the same way, carmakers listed in developed markets are benefiting from the same car ownership trend.
“Take Daimler and BMW,” Lodha says.
“They are both listed in Germany, but are seeing very strong demand in emerging markets like China and India, where their brands hold strong appeal. The brand, in turn, gives them pricing power as well. Pricing power and the uniqueness of an asset are key attributes of the businesses that I like.
“When the stocks of such businesses also have good valuation support that gives a fair margin of safety on investment, they will become part of the portfolio irrespective of where they are listed.”
Research firm Standard & Poor’s says that as the world emerges from the chaos of the GFC, and recovery becomes more coherent, there are attractive opportunities in the small-cap sectors of the world’s sharemarkets.
It says small-cap managed funds can “add attractive characteristics to a balanced portfolio”, including higher returns, but investors should always be mindful of the increased risk and volatility that comes with that.
“They tend to perform better as economic conditions improve, and this has held true as the world recovered from the global financial crisis,” S&P says.
“Small-cap funds have had a strong run in performance over the past 10 years, outperforming mid- and large-caps. In fact, when we look at calendar-year performance over the 10-year period, small caps have outperformed large caps in seven of these.”
But with all investment opportunities, there are potential upsides and potential downsides. S&P says the case for investing in small-cap funds includes:
• Greater growth potential for small companies compared to larger, established firms;
• Small-cap volatility means significant returns are possible;
• Fund managers’ ability to exploit small-cap stock mispricing;
• Portfolio diversification.
The potential downsides of small caps include:
• Greater risks inherent in small-cap investing;
• Small-cap stocks can be perceived to be lower quality;
• Price disadvantage – small-cap valuations may currently be somewhat stretched.
Bottom-up stock pickers are well positioned to find attractive opportunities in the small-cap sector, S&P says.
“Mispricing is a well-documented argument for the active management of global small-cap stocks,” the research house says.
“Opportunities exist as small companies are typically not covered [by analysts] as well as larger, better known companies, so they are often neglected and under-researched.
“Brokers are less likely to cover stocks further down the market cap spectrum, so their stock prices are more likely to behave irrationally and can provide attractive opportunities for fund managers, particularly during times of uncertainty.
