The TAMIM Global Equity High Conviction IMA portfolio has managed to achieve impressive results since its inception. In fact, over one and three years, the underlying fund has outperformed the major Australian based international equity funds. This week Robert Swift takes a look at why it makes sense to have global equity exposure in your investment portfolio.
Portfolio Diversification - What are you missing out on? Robert Swift - 20 October 2016 -
Cast your mind back five years to when everyone was raving on about the mining boom and the Australian dollar was at parity with the US dollar. Australian equities were the way to go and no one dared talk down to us as we avoided the recession.
Now - to use street parlance - “where are we at?”
Our mining sector two years ago drove straight into the Great Wall of China.
Our Banks are loading up on the expensive housing market.
If you are holding Telstra and AMP…well you might as well be giving your portfolio a Prozac.
The point we are trying to make is that our markets haven’t really done much in the past five years compared to the overseas markets. Even INCLUDING the resources boom period, it has been just as good to invest offshore. So why should you be investing in International equities?
REASON ONE: DON’T PUT YOUR EGGS IN THE ONE BASKET
Many Australian investors often cite that they are well diversified because they have investments in property and “blue chip” shares. Wrong and dangerous.
Australia’s stock market is dominated by 4 banks, 2 resource companies and a telecom operator. These 7 stocks comprise over 40% of the available market capitalisation; 60% of the average daily turnover; and about half of the dividend income. The largest 10 stocks account for over 50% of the total market capitalisation. It is a remarkable concentration and probably the greatest concentration ratio amongst the world’s major stock markets as can be seen from the chart below.
This means any portfolio of large cap Australian stocks is highly concentrated in a few names. If you had the nous to invest in small caps you are doing better than a lot of people invested in the market. You can still do better from a return and risk perspective if you had international exposure in your investment portfolio.
The graph below shows Australia’s sector exposure compared to global sector exposure. Now, tell us how diversified you feel only holding Australian stocks.
Your house, Australian banks & fixed interest
Think about what it means to own shares in an Australian bank. You have exposure to the profits derived from loans made to other Australians buying their houses through mortgages.
What is your biggest asset? Probably your house.
So why would you want exposure to other peoples’ house prices as well as your own, especially when there is talk of a housing bubble. Now we are not here to make a call on whether or not there will be a housing market correction, but I most certainly do not want all my equity eggs in the one basket especially when the word “retirement” gets louder as I get older.
“Oh well I have fixed interest also, so my portfolio is safer” - I hear you say.
Well unfortunately you are wrong again, a little realised fact is that the Australian fixed interest market is also very heavily dominated by debt issued by guess who… yes, our Australian banks. So you may think you have diversification by being in fixed interest as well as equities, but you are still highly exposed to bank sector risk.
REASON TWO: THE RETURNS ARE BETTER. THE RETURNS ARE BETTER. YES, ONCE MORE: THE RETURNS ARE BETTER
Sometimes Australia will enjoy the best market returns in the world but most of the time that is just not the case. Now we don’t recommend that you try and predict the best region or country and keep switching around. All we are suggesting is that one should remain diversified across a range of industries and regions at all times.
So what does diversification and higher returns look like in my portfolio?
It looks good. Very good actually. If you invest internationally you get both diversification and the potential higher returns. This results in a more resilient portfolio.
The chart below is slightly more complicated, but bear with us because it is a good one.
It shows the benefits of having different weightings of Australian and international equities (unhedged) over historic time periods. The chart demonstrates this over a 3 and 5 year time frame but it holds true over almost any time period.
The Y (vertical) axis shows return in % per year. The X (side) axis is the risk (the higher the % the worse it is). So you basically want to be as close to the top left corner as you can be and as far away from the bottom right corner.
As can be seen above, the ideal weighting towards the ASX 300 would be 30-40%. Now we do acknowledge that this is a two factor model and there are many other factors and asset classes to consider in reality. The other 60-70% could reasonably be split between some mixture of an international equity strategy and a portfolio of well chosen and thoroughly researched micro, small and mid cap stocks. What else does this graph tell you that is interesting? It indicates that if you are only invested in the upper echelons of the Australian market you have been getting a lower return with greater risk compared to being 100% invested in the international market which has had better returns and less risk.
It is very likely this pattern (as it has been the case for a very long time) will remain the same. Let’s be clear. We are NOT saying that Australian equities will always underperform every year BUT we are saying that even when they are outperforming it may be prudent to lower risk by having some international equity exposure.
Overseas is just more exciting than Australia
Not all innovation will be in Australia. If you are good at identifying the next new trend, then look abroad. There are more IPOs internationally; more patents applied for, and granted, and more spin offs and carve outs from tired old companies with high growth divisions being set free. Here are a few examples.
Mondelez spun out of Kraft foods and has a value of $US36bn with global brands such as Oreos and Ritz.
Agilent from Hewett Packard in 1999 has a value of US$15bn;
AOL came out of Time Warner and was then acquired by Verizon the telephone company;
Intel came out of Fairchild semiconductor and has a market capitalisation of US$175bn;
Yum brands came out of Pepsico in 1997 and is a fast food (yuk) favourite with investors
Alibaba, Tencent, Baidu – all Chinese companies with hundreds of millions of customers and users
China is spending $billions on a New Silk Road linking Chinas’ coast and interior to Asia, the Middle East and Africa. This may benefit the resource companies which provide the steel and stone but many of the beneficiaries will be international companies.
Where is the pharmaceutical industry plan here? The software industry? The technology industry? China is about to become very relevant economically and there are thousands of listed companies there – most readily investable on liquid stock exchanges.
In short there is so much more going on internationally, so why not look to enhance your portfolio a little bit with more diversification? Giving your portfolio international exposure will give it the life and sustainability it will need moving to retirement.
Your investment portfolio needs to be actively managed in the current market environment. If you have no international exposure then it is time you consider adding this to your investments. It is not the time to be passive and sit back with your bank and resource dominated Australian portfolio.
The information provided on this website should not be considered financial or investment advice and is general information intended only for wholesale clients ( as defined in the Corporations Act). If you are not a wholesale client, you should exit the website. The content has been prepared without taking into account your personal objectives, financial situations or needs. You should seek personal financial advice before making any financial or investment decisions. Where the website refers to a particular financial product, you should obtain a copy of the relevant product services guide or offer document for wholesale investors before making any decision in relation to the product. Investment returns are not guaranteed as all investments carry some risk. The value of an investment may rise or fall with the changes in the market. Past performance is no guarantee of future performance. This statement relates to any claims made regarding past performance of any Tamim (or associated companies) products. Tamim does not guarantee the accuracy of any information in this website, including information provided by third parties. Information can change without notice and Tamim will endeavour to update this website as soon as practicable after changes. Tamim Funds Management Pty Limited and CTSP Funds Management Pty Ltd trading as Tamim Asset Management and its related entities do not accept responsibility for any inaccuracy or any actions taken in reliance upon this advice. All information provided on this website is correct at the time of writing and is subject to change due to changes in legislation. Please contact Tamim if you wish to confirm the currency of any information on the website.