Depending on your client’s investing experience, investing part of their portfolio overseas could either fill them with excitement or dread. Investing in portfolios packed with familiar marquee brands, such as Facebook, Visa and Google, appeals to both types of investors.
Those nervous about investing abroad will feel comforted by the stability of these dominant, global franchises. Those excited about investing overseas will latch on to their rapid growth, particularly when the prospects for the typical Australian portfolio loaded with big banks look their meekest in decades.
The problem with buying what’s familiar, or what’s growing quickly, is that lots of other people are doing the same thing. This herd behaviour has increased valuations at unsustainable and risky rates. And with ETF inflows reaching $US347 billion in 2015 alone, the current popularity of passive investment strategies is perhaps guaranteeing more lemming-like behaviour than ever before.
The risks to ETF investors are obvious enough given the wonderful performance of the FANG stocks (Facebook, Amazon, Netflix and Google) in recent years, which are key holdings in many types of ETFs regardless of their valuations. Contrary to common-sense investing principles, the higher their share prices go the more ETFs compete to buy more shares. Fortunately, there is a better way to invest overseas, which applies equally to investing here at home in Australia.
Be bold and be different
As Oaktree Capital’s chief investment officer Howard Marks explains in his excellent tome The Most Important Thing, “You can’t do the same things others do and expect to outperform”. That means avoiding popular stocks where the valuation doesn’t provide room for error or bad luck.
Conversely, it also means investing in less well-known companies that aren’t large constituents in common indexes, or, in financial industry jargon, having high active share. Quite simply, the more a fund manager’s portfolio differs from an index, the higher is the fund’s active share.
The Investor’s Field Guide explains how powerful owning an unusual portfolio of stocks can be, yet then says the following:
“What is amazing is that in the early 1980’s, well over half of mutual funds had an active share above 80 per cent, but as of 2009, only 20 per cent or so of funds were this active … In 1950, between 7 and 8 per cent of the market was managed by large institutions. In 2010, that number was 67 per cent … Investment ‘products’ are increasingly homogenous, coalescing around indexes and titled variations of those indexes.”
This isn’t surprising given John Maynard Keynes had this figured out eons ago: “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”
Yet the fact hasn’t changed. If you want superior returns to the market, you need to do something different. Especially since the rising tide created by the bull market that started in 2009 is no longer lifting all boats. But what should you look for in a fund manager?
What should you look for in a fund manager?
Fund managers that produce outstanding track records aren’t afraid to buy unpopular stocks. So look for funds that aren’t just investing in yesterday’s winners.
Don’t avoid fund manager’s that have had a bad year or two. More recently, value stocks have continued to get cheaper, playing havoc with the long-term records of some of the world’s best investors. That doesn’t necessarily mean a fund manager has lost its magic.
Provided it stays the course, sticks to its process honed over many years and doesn’t start letting the market dictate its investment decisions, then investing now while a fund manager is nursing some bruises could be an opportune time to invest. This is like using the Dogs of the Dow theory to select fund managers.
Growth stocks have recently enjoyed their second-longest winning streak over value stocks ever. Early indications this year suggest that the tide is turning. If you can find a manager that’s prepared to invest differently for intelligent reasons, and you’re prepared to educate your clients on the benefits and risks of investing in managers with high active shares, then investing overseas should simply be another tool in your investment kit – without the high emotion these decisions often produce.
