March 2016

GLOBAL EQUITIES: The end of a worldview

EarthGeographical fund mandates have fallen out of favour, to be replaced by sector-specific approaches. However, Kit Klarenberg finds this development is not without risk.  In recent years, global equity funds have increasingly moved away from regional mandates towards sector-specific orientations.  There are many reasons for this paradigm shift. Stock-picking on a country- and region-specific basis has never been trickier. Making the right calls demands extensive research, localised knowledge and first-hand experience of a region’s constituent companies. Such detailed examination is beyond the capabilities of many firms.  Conversely, investing by sector allows asset managers to focus on a well-defined market area, and pour all their investigative competences into finding the best opportunities on that patch. This expertise can then be used to generate returns in excess of those offered by their diversified, generalist counterparts – theoretically, at least.  “Looking at sectors globally expands an investor’s opportunity set, enables far broader comparisons and better evaluations of individual securities,” says Raj Shant, global equities portfolio manager at Newton Investment Management. Some believe there’s an academic case to be made for sector-specific investing, too. Among them is Hugo Rogers, global equities fund manager at Liontrust. “In developed markets, the performance of individual sectors, industries and companies is the primary driver of stock price performance – and this is fast becoming the case in emerging markets, too,” he says. “In most cases, superior profits or sustainable economic advantages will be reflected in prices, no matter the geography, and if these profits and advantages cross geographic boundaries, superior returns will also cross geographic boundaries.” In other words, equities will perform according to the strength of their sector, and themes they are exposed to, irrespective of where stocks are listed. It’s probably true that an industry-specific view on equities is a highly logical one in an increasingly globalised world, where products, information, ideas and people travel rapidly and straightforwardly.  While certain sectors do not cross international borders easily, nowadays most do. Medical research in Cambridge produces drugs and devices that are adopted, sold and further developed by pharmaceutical firms in both the developed and emerging world – and tech firms in Seoul, Tel Aviv and Tokyo can absorb innovations born in Silicon Valley almost overnight.  FAD DIETING
Another attraction of sector-specific positioning is that it can translate into a strong marketing advantage for a fund. Media buzz around particular industries and assets often sends investors racing to get involved, and sector funds can reap significant inflows from the heightened interest.  However, it is precisely the ‘trendy’ nature of sector-specific investing that has made some wary of its rise to prominence. Among them is David Hogarty, head of strategy development in Kleinwort Benson Investors’ global equities division.  “Trends are a huge problem – investors have gotten overexcited about a number of sectors over time, but the hype has often been short-lived, and the trends have come and gone,” he says.  “Every industry has its winners and losers. For instance, sector-wide investment in the smartphone industry exposes you to Apple, which is booming, but also Blackberry, which is almost bankrupt.” Dan Brocklebank, director of Orbis Investments, is similarly concerned about investment strategies structured around trends. He says en masse pile-ins to sectors typically inflate valuations to vertiginous levels – in many cases these heights are artificial, and dangerous.  Moreover, when an industry is regarded as ‘hot’, it can cultivate an assumption that every business in that space will benefit to the same extent. The reality is that in any industry some stocks will flourish, and others will struggle.  “The dotcom crash is an extreme example of this phenomenon. At the turn of the century, prevailing wisdom stated the web industry was the place to be – but if an investor bought the sector at that point, not only would the stocks have cost a premium, many wouldn’t exist come 2001,” he says.  “Furthermore, that investor’s exposure to the best of the crop – such as Amazon and Google – would have been small.” George Maris, portfolio manager at Janus Capital Group, finds sector-focused portfolios problematic on much the same basis. “The volatility in sector performance, even when fundamentals do not change dramatically, means a sector prediction can easily go wrong and swamp the stock-picking prowess of portfolio managers. Consider the dramatic reversal in the financial sector in 2009,” he says. “In the last 20 years, every MSCI Global Industry Classification Standard sector bar one has been both a top performer and bottom performer in individual years. We think making sector picks is the largest source of uncompensated risk in equity investing.” HERE TO STAY
While the perils of en vogue investing should clearly not be understated, wise asset managers are surely aware of them – and accordingly make distinctions between transitory fashions and enduring drifts and shifts. Graeme Bencke, head of equity strategy at PineBridge Investments, says: “When looking for genuine trends in an industry, we need to see tangible benefits from the change – fads tend to reflect a change of preference or fashion, with little in the way of definable and repeatable benefit.”  Rogers at Liontrust says a disciplined approach to portfolio construction is paramount. Each holding must work on a standalone basis and stack up in respect of valuation and earnings. Moreover, being benchmark-agnostic means funds avoid being heavily invested in a sector’s priciest firms at the top of any cycle.  So, what are some examples of long-term, structural themes? Rogers tips water and agriculture. Demand growth is driven by population growth and long-term global development, he explains. There is genuinely no substitute for either.  An ageing population is another example. The world over, consumers aged 60-plus are an expanding and increasingly cash-rich crowd, less sensitive to wider economic circumstances than the majority of the population.  Businesses serving seniors are scheduled to grow faster than the rest of the economy, and constitute a sizeable and diverse universe of stocks – pharmaceutical, financial and consumer-discretionary firms are primary beneficiaries of this demographic shift, but so are secondary industries that supply the primaries.  In both instances, there is no ‘killer app’ or ‘alternative technology’ on the horizon that could reverse these trends, and render the sectors and businesses benefiting them obsolete.  However, funds are still urged to pick not only their themes, but their thematic portfolios, carefully. A 2015 Morningstar analysis of sector fund performance underlined just how precarious dedicated funds can be – both for providers and investors. The findings indicated many sector funds missed the boat, launching belatedly, and merely offered investors the dubious opportunity to buy high as markets peaked. In essence, managers (and investors) opted to overweight a sector when its rally was over. Worsening matters, burned investors then quickly sold, effectively sinking many sector funds. Still, despite the hazards and naysayers, it’s evident the sectorisation of global equities is here to stay. Asset managers simply can’t afford to be region-specific any longer. As a result, geographic funds and investment approaches may soon be a thing of the past entirely. ©2016 funds europe

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