International equities: When home bias wanes

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The reckoning that was the 2008 global financial crisis sent Australian investors running for shelter, turning their backs on equities in place of more stable and unshakable investments like government bonds and consumer staples. 

Ten years on from the GFC, it’s fair to say allocations to equities haven’t quite recovered, and as Aussies fly the coop in search of greener pastures to fulfil their diversification needs, allocations to international equities in super funds have equalled (and even outweighed in some cases) their Aussie counterparts. 

Chant West senior investment research manager, Mano Mohankumar, says that around 10 to 12 years ago, the equity landscape saw around 31 per cent of superannuation fund portfolios allocated to Aussie shares and 27 per cent to international shares.

Mohankumar says the playing field is now fairly level, with both equities allocated about 27 per cent each way, which actually shows a depletion in allocations to equities as a whole.

Australian Prudential and Regulation Authority (APRA) data also tells us that as of June 2018, those superannuation funds with more than four members (essentially every superannuation fund bar self-managed superannuation funds), have decreased allocations to Aussie equities to around 23 per cent, and international is up to 24 per cent, which is an increase from September 2013 when Aussie equities were at 25 per cent and international at 17 per cent.

The MySuper cohort had a similar increase in international equity allocation from 22 per cent in 2013 to 29 per cent in 2018, with the average allocation across both sectors evening out to around 26.5 per cent, in line with Mohankumar’s estimation. 

Frontier Advisors director of investment strategy, Chris Trevillyan, added that historically, industry superannuation funds on average had around a 40 per cent allocation to international equities, but now it’s at around 50 to 60 per cent depending on the fund. 

So, while investors look to be decreasing their overall equity allocation after being burned by the GFC, it’s not at the expense of international equities, and their ability to diversify portfolios has played a big role. 

“In terms of diversification, the Aussie market is somewhat limited compared to global markets, both in terms of countries, but also sectors as well,” says Mohankumar. “So, while we’re typically geared towards financials, there’s just so many more opportunities overseas.”

Mohankumar says what’s been taken out of Australian equities has been reallocated elsewhere, to asset classes like unlisted property or alternatives.

“Again, it comes down to trying to get better returns and further diversifying your portfolio,” he says. 

Trump, trade and emerging markets

While global politics is making a lot of noise at the moment, the consensus among industry experts is that it’s probably nothing more than that. 

Both industry and retail super funds agree that trade tariffs really only have an affect over the medium term, but over the long term, those economies will continue to evolve and develop, and deliver reasonable growth and returns. 

Sunsuper’s listed shares manager, Greg Barnes, says while the global political climate is obviously something to think about, the trend in decreasing global trade isn’t really new, and the most recent dispute between the US and China is just a continuation of that process. 

“If it does escalate then it certainly has the potential to have not only implications for both the US and China but EMs (emerging markets) and the broader global economy in general,” he says. 

Portfolio manager at Colonial First State, Peter Dymond, echoes Barnes’ statement, driving home that the fund doesn’t make short-term moves based on geopolitics, but rather sticks to a long-term horizon. 

And, while EMs have suffered at the hands of developments in countries like Turkey and Brazil, super funds should still be putting their money towards them. 

If not for the significant diversification they provide, much like a lot of other international equities, then for the attractive long-term returns they’re capable of producing. 

Barnes says though the fund has recently scaled back their allocation to EMs a little, it has always had quite a reasonable allocation to the asset class, primarily because of the potential for a higher level of returns and diversification – both through to the underlying markets and economies and also their currencies.  

But, they do attract their own fair share of risk, so Barnes warns that, in terms of portfolio allocation within EMs, careful attention needs to be paid to asset selection. 

Trevillyan adds that while emerging markets equities faced significant risks from trade restrictions, rising US interest rates and the rising US dollar, in general they were reasonably well positioned. 

“Although specific fragile markets such as Turkey, Argentina and South Africa are fundamentally weak, emerging markets in general are reasonably positively positioned,” he says. “Emerging market equities have materially underperformed developed market equities and valuations are appearing more attractive.”

Grant Forster, Australian CEO of Principal Global Investors, similarly expresses concerns for Turkey and Latin America, citing a lack of central bank independence and political unrest as key deterrents. 

What he does like, though, is Eastern Europe, particularly Russia, and of course most Asian markets, which he says have been acting very responsibly in their raising of interest rates to ensure inflation doesn’t tip the boat over. 

“Hong Kong, Korea and Taiwan have had a really tough time this year, but along with valuations, we think they represent pretty good value at these levels,” says Forster.

Additionally, one thing that’s pretty clear across all portfolio managers and senior executives is that China is not an emerging market to miss, so much so that some believe it warrants its own separate category. 

The growth of the opportunity for investing in China has increased significantly, whether it be through large Chinese tech companies that are listed in the US, or the inclusion of China A-Shares in the main family of the MSCI indices. 

But, experts are worried it looks to come off a lot worse than the US once the tariffs are imposed given it has had such an export-led economy for the last 25 years – a huge chunk of which has been going to the US. 

US leads the way

Equities in the UK have lagged following Brexit; we’ve heard the political issues in Brazil and Argentina have caused trouble in Latin America; and in Turkey, President Erdogen’s attempt to influence the central bank raised issues of independence, but the US still remains a powerhouse. 

It’s had its own fair share of political uneasiness, what with the surprise election of Trump and his decisions that followed, but the US economy is actually in the best shape it’s been in since the GFC, posting quarter after quarter of economic growth, with 16 to 20 per cent growth this year alone. 

Trevillyan acknowledges that, across the board, geopolitical concerns have appeared to have had limited impact on equities, highlighting that US equities in particular have continued to rise with barely any blips.  

The US, particularly US tech stocks, has actually been a continued key driver of international equities’ performance, and Trevillyan says the US equity market currently trades on a price/earnings of more than 20 times. 

These strong US equity returns, says Trevillyan, have been driven by strong earnings growth, supported by economic growth boosted by fiscal stimulus and corporate tax concessions. 

“The technology sector has experienced very large growth, increasing to be more than 25 per cent of the US stock market value,” he says. “The US technology sector has produced around a 400 per cent total return over the last 10 years.”

Unlike the tech bubble period of the 2000s, the technology sector’s performance has been driven by strong earnings growth, and stocks often have strong fundamental positions and strong margins on high revenue growth. 

Sunsuper’s Barnes says the US was foremost among a small number of international share markets that have actually been performing strongly, which is attracting a lot of attention from investors who are chasing the best-performing market. 

But, that’s actually made the market expensive, so the fund is currently underweight the US and overweight Europe, which, from a top-down perspective, is counter the performance of those markets. 

“From our perspective it’s about identifying good quality companies and good underlying investments,” he says. “To some extent, irrespective of where they’re listed – obviously the country where they’re listed will have an effect – understanding the broader performance drivers of those companies tends to be the primary investment decision we’re making rather than a macro-geographic allocation.”

Will investors leave the nest for good?

Home bias has definitely waned, but whether that bias will disappear completely is another story. 

Certainly, the experts aren’t convinced that international equities are going to continue to gain the same amount of traction, instead opting to say they may grow at a slow and steady pace. 

“Ten years ago, we could say with great confidence allocations to international equities would certainly increase, and it has increased a little bit, but it’s really hard to tell whether it’s going to increase significantly or not,” says Chant West’s Mohankumar.  

Though he couldn’t say decisively, he thinks we’ll probably see a little bit more allocated to international equities in the coming years at the expense of Aussie shares. 

Trevillyan similarly points to a general trend in equity allocations reducing as investors look to reduce risk in portfolios, but there is an uncertainty as to what will come of geopolitics and trade tensions, and the impact it will have on general sentiment. 

Forster agrees in that he believes equities as a whole probably won’t increase, but he’s fairly confident allocations to international equities will continue to grow. 

“We’re just starting to realise that we’ve got so much important retirement money really over-exposed to a very small equity market,” he says. “Our equity market is only two per cent of the world’s equities, yet we’ve got 25 per cent of our savings tied up there.”

The superannuation funds agree too, with Barnes noting that funds are looking to provide a long-term diversified income stream for their members in a way that offsets their strong domestic exposure, which naturally leads to higher offshore portfolio exposure. 

Dymond similarly notes that the trend has been for home country bias to come down, but he says it still has a long way to go. 

For CFS, the last six months has seen a portion of Aussie equities move into global small companies, which introduces a new building block to add further diversification, something Dymond says is just a continuation of the trend to reduce home country bias. 

Dymond says looking down the track though, changes to franking credit rules might influence that appetite.

“Whilst those franking credits are there that helps entrench that home country bias, but if they were to disappear that might accelerate the move away from Aussie shares, but I do see it as a gradual trend,” he says. 

Barnes agrees there will be a limit to seeking growth opportunities offshore, and Australian shares will represent a significant component of pension fund assets given franking credit domestic share ownership, but the trend will continue in a “steady and measured fashion”.

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