03 Aug Leaning into the wind – International Equities
Ever wonder about the place International equities has in your portfolio? Financial Planning magazine asked David Graham for his views on this asset class and we’d like to share this with you. Enjoy!
International equities have been an asset class that we have long seen as providing additional diversification benefits. The breadth of companies and sectors in the global space far outweighs that available in Australia.
Nevertheless, it remains a hard sell to some who reflect a strong home country bias. It was a particularly hard sell before the GFC, with Australian equities performing well and a strengthening Australian dollar sapping the returns of unhedged global equity exposure from time-to-time. Moreover, the range of vehicles available was significantly narrower than the range currently available.
Since the GFC, we have been using global equity funds that are generally of a more specific nature and more reflective of our underlying investment philosophy. This philosophy is based on the idea that markets rise and fall, but quality companies keep growing their returns to shareholders and thus recover their price and provide long-term returns despite market movements. We have been able to select a range of managers that reflect this approach to varying degrees within specific sub-sectors.
In building a portfolio in this asset class, we also vary the manager type – that is, global small caps, emerging markets, yield driven, concentrated core and so forth. Overlying this selection, we determine a broad currency position by selecting some manager options that are hedged and some that are not. In other words, if we have five managers of equal weight and want a 40 per cent hedged position, two of the managers will be a hedged version. Implied in the latter is the fact we use managed funds in this sector.
We have looked at direct share approaches, but have not discovered an option that provides the same level of management skill or diversity. We look at ETFs from time to time, but the index approach does not sit comfortably with our quality overlay.
I see a disconnect with some clients who concentrate on the management expense ratio rather than the management skills. The academic evidence says you can’t outperform the index, but anecdotally, we keep finding people who do. Maybe this is because ‘quality’ has been in vogue for the past six years or so.
Having had this approach for some years, our client portfolios have benefitted from the relative outperformance compared to Australian equities. This means more recently we have been trimming positions, taking some profits on global equity exposures.
Within the sector, we currently have a slight bias towards emerging markets due to more attractive valuations. However, this needs to be approached with caution. China has been on fire for the past year. Via manager selection, we have tried to avoid direct or indirect exposures where possible, as this appears to be the biggest stock market bubble since the tech wreck.
In addition, we expect that many of the managers we use will tend to underperform raw indices in a momentum driven market. This is the natural outcome of a quality driven approach when the market gets a little excited and forgets about the basics. We explain this to our clients in terms of the long-term risk adjusted returns we are trying to generate.
I note that the global equities sector is probably looking more attractive to clients in light of the relative performance of local equities of late. In some respects, they are about four years too late.
This does not mean they cannot enjoy further upside in global equities in the next few years, especially if the Australian dollar continues to weaken.
However, the best may already be behind us in this cycle. This is why we are taking some profits from this sector. We aim to ‘lean into the wind’ in an incremental and systematic manner.
It’s not always easy to convince clients of this approach, but that’s what advice is all about.
David Graham CFP® is a senior financial planner at McPhail HLG Financial Planning, now known as Sigma Wealth Management.