In a low-return environment, Australian investors have more incentive than ever to look beyond the local market to boost their returns. Ben Power explains.
Download a PDF of the full In Focus feature, Adding foreign flavour to the investment pie.
Australian investors are struggling to find good opportunities, particularly with government bonds and banks overvalued, and resource stocks hit by a China slowdown. In a low-growth, low-return environment that makes it difficult to find value, investors are being urged to take a global approach.
“In this low-return environment, global investing gives you a bigger set of opportunities to hunt down value,” says Oscar Pulido, managing director and member of the BlackRock Global Allocation Team, which helps manage the BlackRock Global Allocation Fund (Aust).
While the world economic growth is still slow and major markets like the US have run hard, analysts say the global investor can find good returns in beaten-down Japanese and European stocks, and in sectors that are not available in Australia, such as automotive, pharmaceuticals and aeronautics.
Wherever Pulido travels around the globe – whether it’s Europe, the Asia-Pacific, the US or South America – investors prefer investing at home.
“It’s what they know – companies they know; it’s where they grew up and it feels comfortable to them,” he says.
International investing does carry some risks, including currency risk. For this reason, many investors choose to hedge their portfolios, and the BlackRock Global Allocation Fund (Aust), for example, is effectively hedged against $A movements.
Focus on fixed income
Relatively cheap
However, the strong $A makes international investments relatively cheap; and unhedged international assets can provide an inbuilt “shock absorber” in portfolios: when global markets sell off, the $A usually falls too, which boosts the value of offshore holdings.
Chad Padowitz, chief investment officer of international value investor Wingate Asset Management, says that over time, currency fluctuations even out and are not a major factor.
A global approach to investing brings other benefits to investors, particularly diversification. Perhaps the strongest argument in favour of international investing is the concentration of the Australian market.
Padowitz says Australia-focused investors think they are making a country-based asset allocation decision, but they are really betting on the performance of retail banks and resource stocks.
“To significantly skew to just those two sectors seems quite extreme,” he says, adding that banks are overvalued and resource stocks are exposed to a slowdown in China.
Chris Marx, senior portfolio manager of global equities at AllianceBernstein, says investors in Australia don’t have exposure to attractive sectors, such as autos and aerospace. He says that while post-GFC car sales slowed, auto companies have since restructured and have a lower cost structure in place, so they can produce profits at much lower production levels. With cars getting older, pent-up demand from buyers has boosted the volume of auto production. Auto companies, and parts suppliers, will continue to benefit when confidence and demand return.
Similarly, the aerospace industry is benefiting from a growing middle-class in emerging markets, which is demanding more air travel; that, in turn, is boosting demand for aircraft.
“We see sustained demand for aircraft for a while,” Marx says, and that will flow through to engine manufacturers.
While ideas like autos and aerospace are appealing, “it’s tough to access if you limit yourself to a single country or region”, Marx says.
Focus on sectors
Outside opportunities
Australian investors, therefore, need to be more aware of investment opportunities that might exist outside their home market.
“There are many areas that look pretty compelling from a price perspective,” Pulido says.
At the regional/country level, Pulido says value investors are being paid to take risk, particularly in Europe and Japan, but it is time to take profits in US stocks.
Japan seems to be willing to make structural changes to its economy, he says, which could help unlock its stockmarket, which has been cheap for a very long time. Despite the Japanese rally this year, Pulido says the price-earnings (PE) and price-to-book (PB) ratios in Japan are historically cheap. He likes Japanese auto stocks, which are benefiting from local and Chinese demand.
There has also been an improvement in economic data from Europe, which could signal an inflection point, Pulido says. He says that one of the most distressed European economies, Spain, just posted a positive quarter of GDP growth. But while there is an improving economic picture, the market trades at a discount.
“We’d argue that discount won’t exist forever,” he says.
Pulido says the BlackRock Global Allocation Team has been adding to its industrial sector holdings.
By contrast, BlackRock is underweight and reducing its exposure to US stocks, including telecoms. At 14 times forward earnings, US stocks don’t look compelling on a relative basis, he says.
“That’s if you believe the forward earnings used,” Pulido says, adding that BlackRock believes estimates are too optimistic and have room to come down.
“It’s time to start taking profits in US equities.”
Less conviction
There is less conviction when it comes to emerging markets. In the past two years, BlackRock has cut exposure to emerging markets, including countries such as China and Brazil. But that stance could start to change, Pulido says. He says a lot of investors are “starting to throw the towel in” when it comes to emerging markets. “That could open up some windows of opportunity,” he says, though he adds that it is not a homogeneous category. BlackRock is increasing its weighting to some countries, such as South Korea.
There are also sector-based opportunities outside Australia. Padowitz says that in a slow-growth environment, where the pie isn’t expanding, industries and sectors are fighting each other for scarce dollars. Investors need to get exposure to companies that are taking “shares of dollars”. The health care sector, for example, might be taking dollars from consumer spending.
“As an investor, you need to find which industries and which companies within those [industries] are going to be able to take market share – by that I mean ‘share of dollar’, ” he says. “The more places you can look at and the more industries you’re allowed to explore, the greater the odds of finding one.”
The outlook for resources is also uncertain as China shifts to a service- and consumer-oriented economy. Padowitz says it will be less capital-intensive, which will impact on prices, or at least demand, of commodities.
“That has an impact on BHP and Rio,” he says.
“That’s dead money for a while on that side [resources], and we think the banks are expensive,” he says.
Pulido agrees that Australia is particularly exposed to a slowdown in China as it transitions to a more consumer-focused economy.
“How that affects the Australian economy and stockmarket is really hard to know,” he says. “But we challenge the Australian investor to say they are positioned for that.”
The best way to be positioned is to diversify, and that includes looking globally for opportunities.
