Getting the global mix right
What does global equity actually mean? The globalisation of markets over the past decade has resulted in a shift away from region-centred research by investment managers. The shift to more global sector research is the trend that has shaped the new environment for global equity investment.
Investment managers in today’s markets have a broader set of opportunities within global equity. Many important investment themes are global in nature and the best investments may exist in emerging rather than global markets. Global managers enjoy a freedom to roam across markets to seek out these opportunities. Country allocation is not the driving force it once was. But while markets are increasingly driven by global sector themes, opportunities to exploit country mis-pricings still exist and global managers are in a better position than regional managers to exploit this.
Global equity managers are typically running less constrained and more concentrated mandates now. In 1996, only a third of the 40 managers researched by Russell Investments focused purely or predominantly on global products. Russell now researches 100 global equity managers and 80% of these are boutique managers focusing on global investing alone. The global managers have also significantly outperformed those offering predominantly regional mandates. While much of this performance has come from stock selection, global managers have better exploited opportunities such as the underperformance of US equities and the outperformance of emerging markets.
Overall, it appears that global equity managers are able to outperform the combined average US and non-US approach, at least over the last seven years. The evidence is less conclusive over longer time periods. Russell research shows that large-bet global equity managers outperformed small-bet global equity managers by 180 basis points from 1990 to 2006. The large-bet managers had an information ratio of 0.45, compared to 0.20 for the small-bet managers.
A global manager approach is also suitable for investors with the following characteristics:
- Investors are in countries with small market capitalisations, or they have smaller home-country biases.
- Investors want to have a separate account, but their plan sizes are fairly modest.
- Investors want to avoid the complexity of fund administration and investment management
To meet their risk and alpha targets, these investors might consider using a global-equity-manager-only structure and investment guidelines to specify their country and sector restrictions.
From a risk perspective, Russell research shows multi-manager global equity structures become more appealing relative to the combined US + Non-US equity manager structure, due to the two main contributors. First, the impact of the global manager’s style on manager performance and risk becomes more important. Second, the global manager’s bets on the three largest countries - the US, the UK and Japan - also decrease. Therefore, diversified style risk and a decline in country risk lead to a decrease in active risk of multi-manager global equity funds.
Through portfolio simulations employing the same number of managers, Russell’s research shows that active risk for global multi-manager funds is only approximately 80 to 150 basis points higher than that for US + Non-US multi-manager funds.
Symon Parish, chief investment officer for Russell’s Australasian operations, suggests a multi-manager global structure is a logical default for many Australasian investors, “as the range of products marketed here has been largely limited to global products. Intuitively, a global mandate makes sense as it allows managers to make trade-offs within the widest opportunity set. The limited asset size of many investors also makes this an attractive starting position, as reasonable diversification and coverage of the investable universe can be obtained with a relatively small number of managers.” Historically, this approach has been constrained by the small number of high quality manager candidates. In addition, very few products incorporated truly integrated global processes - many were merely regional components bolted together, providing diversification but dampening the impact of stock selection.
At the other end of the spectrum, a regional approach can be adopted. This structure takes advantage of greater specialisation by regional managers and allows more control over country bets and hence the active risk within the portfolio. However, this comes at the expense of greater complexity and higher costs - for example, if multiple managers were used within each region to achieve style and investment process diversification. The regional approach also suffers from the inability of managers to weigh up relative valuations of similar stocks from one region to the next.
A US/Non US approach overcomes some of the shortcomings of the global and regional approaches. From an investment perspective, it retains much of the potential alpha sources while ensuring appropriate specialisation in the US. It also provides greater control of country risk and compensates for the historical tendency of managers to underweight the US. From a practical standpoint, there are considerably broader and deeper lists of quality US and Non-US managers compared to the global opportunity set. Nevertheless, this approach still requires a sizeable asset base to achieve good manager and style diversity.
The discussion above highlights that each structure has its own strengths and weaknesses and that a well balanced fund can be constructed in a number of ways. Historically, a global structure has been preferred largely for its simplicity and economy, particularly for investors with smaller asset bases. For larger investors, the US/Non-US approach has offered more flexibility, a better choice of managers, and a good balance between alpha potential and risk control.
The result of these developments is that sector influences have become much more important while country has moderated as a source of risk. Put another way, many companies are increasingly less influenced by domestic events and more by global trading conditions for the particular sector. For instance, a mining stock in Australia is now more likely to “behave” like other mining stocks around the world and less like other Australian (non-mining) stocks compared to a decade ago.
The rising importance of sector over country implies that a manager whose research is aligned by global industries should have a broader perspective in comparing relative valuations and earnings prospects of similar companies across countries, than a manager who research focus remains aligned solely by country or region.
It is therefore not surprising that managers are increasingly organising their stock research effort along sector teams and away from country/regional teams, where often there is no consistency of approach from one region to the next. Managers that have made this move include Capital, Fidelity, Putnam, JP Morgan, UBS and BlackRock.
The two main growth areas within the global equity space are first that we will see more concentrated, unconstrained strategies. Secondly, there will be more themed global products appearing.
The appetite for aggressive product remains strong says Symon Parish. “We expect to see a growth in concentrated products, limited long short (130/30) strategies, absolute return driven approaches and managers investing in a wider variety of markets, including frontier markets and even convertible bonds.”
As investors look for more niche strategies, managers will have to embrace new specialists mandates. For example, those offering mandates based around Islamic Shariah principles or Socially Responsible Investment will be well backed in Asia. Parish observes, “Global equity managers have a broader opportunity set and with advances in information technology, the research gap between regional managers and global equity managers is narrowing.