Going global

We ask five industry experts for their thoughts on global equity investing

Colin Robertson, Global Head of Asset Allocation, Hewitt




Investors have been looking for the green shoots of economic recovery and their sighting has been a major driver of equity markets from their March lows.

So far, the good news has come largely from slowing falls in output, as distinct from actual growth, but inventory rebuilding may provide more visible green shoots later this year. The snag is that an inventory rebound is transitory, typically petering out quite quickly and a durable economic recovery based on higher spending by households and firms is still some distance away.

This has led to the situation where, in our view, UK and European profit forecasts are now realistic for 2009 but remain too optimistic for 2010. In the US, where the collapse in profits started sooner, expected profits growth for large companies in the years ahead looks more reasonable but small cap analysts have lagged in cutting their forecasts.

Leaving aside the scope for sentiment to be hit when profit shortfalls are announced, this means that valuations are not as cheap as they seem. On price earnings ratios which take into account only the next 12 months' profits, UK and European equities look cheap. However, when valuation measures are used, these markets now appear more fairly valued. In contrast, the US and Japan look cheap on equity risk premia but only fairly valued on price earnings ratios. In short, the cheap valuations we saw earlier this year have disappeared. Therefore, while we certainly think investors should be holding equities for the longer term, we believe there is no great rush to buy more at this time.

Henry Boucher, Deputy CIO, Sarasin & Partners

Throughout the bear market there has been almost no differentiation between the performances of regional equity markets (other than currency movements) and looking forward it is clear that no single developed stock market presents a strongly differentiated investment case. This makes the task of asset allocation by geographic region particularly difficult, but it is the ideal environment for thematic investing.

Unemployment and the need to pay down debts may leave the general growth in developed market profitability subdued for a considerable time and investment opportunities will need to be picked out from more specific growth trends. However, profits and growth can be found, whether it is in the pattern of increased government expenditure or demographic pressures, in technological changes or a variety of other 'themes'.

Many investors have begun to allocate portions of their portfolios to individual themes and there are some promising growth oppor-tunities, for instance in agriculture and food where the drivers are population growth and diet change - very different from the factors leading the wider global economy.

To achieve diversification and to capture the best of the available global equity opportunities, some investors are seeking out broadly based thematic funds. A global thematic equity fund has the free range to find growth trends, regardless of geography, but also balances the portfolio risk and searches for new themes.

Globalisation has meant that most companies are now multi-national and the various local market indices just represent a different collection of global companies. Stock selection is challenging enough in current market conditions without the market correlation and asset allocation issues that this trend creates. Investing in themes rather than countries or regions may well be the way forward.

Mustafa Sagun, Chief Investment Officer, Principal Global Investors

We believe the Asia region and emerging markets in general will be the greatest beneficiaries of a revival in global growth.

The key to a turnaround in the economic cycle will be a recovery in the U.S. consumer, and more specifically, the U.S. housing market. While many cycle indicators are pointing to a recovery, including improved consumer sentiment, higher retail sales and lower job losses, the recovery in the housing market has not been confirmed. Also, high profile potential bankruptcies and political risk in both developed and emerging countries are not priced in the market and continue to be a substantial risk until economies improve globally.

The impact of the various stimulus packages around the world will drive new trends. The recovery in China infrastructure investment will be good for oil and select commodities. US stimulus funding for research and development in clean and efficient energy use, as well as new investments in health care, will drive growth in related stocks. Also, continued deleveraging of corporate and individual balance sheets in the US will provide opportunities for select financial companies as the domestic savings rate increases.

Although valuations have expanded since March, they are still below historical valuations that correspond to periods of economic recovery following a bottom in corporate earnings. Historically, we have seen P/Es expand to 16-17 times when earnings bottomed and a recovery was in sight.
We believe S&P 500 earnings have already bottomed or will do so in the second quarter. If this is true, current valuations of approximately 14 times (one-year forward) earnings are at a discount to historical P/Es in similar periods. We believe the market will continue to act positively as the earnings recovery takes hold in the next two quarters.

As market volatility decreases, correlations also decline. A decline in correlations means that individual stock selection, rather than macro concerns, will once again be in focus – welcome news for stock pickers.

Doug Naismith, Managing Director, Institutional, Fidelity International

In 2008, as world markets tumbled, global equity was one of the most searched-for asset classes by UK DB pension schemes. Over time, global equities have shown a good ability to generate consistently strong returns and so the scramble to increase allocations shouldn’t be surprising.
Global equities hit a bottom in early March 2009 and, while gains since then have been very sharp, markets are now volatile.

Perhaps a key question should be less about the potential for growth and more about why schemes would want an asset class that can be so volatile? A short answer is diversification – allocating to world markets gives managers of pension fund assets a potentially vast opportunity set and, in some cases, the opportunity to marry global leaders with undiscovered gems in the same portfolio.
A second answer is now very apparent – volatility can give a fund manager an excellent opportunity to pick stocks. Today, after a market rally in which all sectors rose broadly in line with each other, drilling down to the underlying stock level has never been more important.

When valuation gaps within sectors, between sectors and between markets close, those fund managers who can select preferably cheap stocks, irrespective of sector should be in a position to continue delivering attractive growth. I would expect this approach to do better than those relying on large sector bets.

Amid the worldwide stock market plunge, global equity correlations – already at an all time high – continued to rise as markets converged aggressively to the downside. This served to evaporate the benefits of equity portfolio diversification and magnify investor losses. The global nature of the current economic contraction makes such broad-based equity fallout understandable, but it is important to remember that while losses have been amplified by the rising global equity correlation, this trend has boosted gains as markets have largely recovered in unison.

Alec Young, International equity strategist, Standard & Poor’s

While weak recovery trajectories and full valuations are likely to limit second half developed market appreciation, we believe emerging market equities boast a more robust recovery outlook as faster upward EPS revisions have driven year-to-date emerging market equity outperformance.

Within this grouping Asia and Latin America afford the most opportunity with EPS revision ratios of well above those of Emerging Europe, the Middle East and Africa (EMEA). This trend is also reflected at a country level with the best performing nations such as India, China, Taiwan and South Korea, falling within Asia. The out-performance of Asian and Latin American nations can be attributed to their healthier macro-economic backdrops, characterised by aggressive domestic stimulus in China, the potential for significant economic reform in India and scope for additional central bank easing in Brazil. In contrast EMEA nations will continue to suffer due to high external debt that will continue to place a burden upon second half economic prospects.

We believe emerging market equities represent a leveraged play on global growth, with the asset class tending to suffer more when growth contracts and appreciate more as it recovers. As such, as the global economy continues to recover, emerging market equities remain attractive with continued upward EPS revisions, modest P/E expansion and the asset class's higher beta relative to developed markets.