For a long time now, super experts have been suggesting that the Australian equities performance bubble, so long the backbone of double digit returns for funds, is sure to burst at some point. Cautious recommendations to increase global equity weightings have been the order of the day, yet funds still seem better served by staying local. However, according to Fiona Trafford Walker, managing director of Frontier Investment Consulting, that must, if it hasn’t already, change.
“I think the strength of the local market has surprised people,” said Trafford Walker. “And there have been good reasons for that strength, particularly with respect to private equity activity. However, we would still say the Australian market doesn’t offer the same value that international markets do.”
Trafford Walker said Frontier’s advice to clients was still to retain one-third of their allocations to domestic equities, but stressed that at present, there were better opportunities to be found offshore.
Russell Bye, managing director and investment manager, international equities, for Credit Suisse, also saw a great deal to be gained from increasing global weightings.
“The international market looks even better when compared to domestic equities than 12 months ago,” he said. “If you look top down at P/Es (price-earnings ratios), all but one market sector is performing better internationally than domestically, and that one sector dominates only because of the strength of BHP and Rio(Rio Tinto) .
“With earnings growth for international markets slightly larger than here in Australia, and with the domestic market set to come back cyclically, global equities certainly seem the best option,” added Bye.
Alternatively, Jeff Bresnahan, managing director of fund research house SuperRatings, still sees most funds exercising caution when it comes to investment offshore.
“I’d say most funds remain confident about both global and domestic markets,” he said. “We haven’t seen any material weighting shift away from domestic equities towards the global markets to date.”
So while views that Australian domestic equities are looking more and more expensive when compared to their international counterparts continue to be prominent, opinions seem divided on allocation shifts and strategies.
Contrary to Bresnahan’s belief, Trafford Walker said she thought there had definitely been pronounced allocation shifts towards the global markets within super funds.
“Domestic equities have looked expensive in terms of the earnings cycle for some time now,” she said. “And the P/Es have looked better because of this. But it is an increasingly narrow market.
“Superannuation allocations will always move slowly,” continued Trafford Walker. “But we have seen many clients re-weight from around 20 per cent to as high as 28 or 29 per cent in international equities.”
For Bye, domestic equities definitely stack up to be more expensive than global equities under current circumstances.
“I don’t think there can be any doubt on that,” he said. “Resource companies are, of course, an exception, and there are others here and there, but on the whole, the global markets seem to be presenting better opportunities.”
Alternatively, Bye admits many people find moving away from the markets that have served them so well for so long difficult.
“There are still good yields to be had domestically,” he said. “Particularly with respect to franking dividends. A lot of the private equity activity that has taken place across all markets has had a greater effect here in Australia than it has overseas, and these things make the realisation that better value exists offshore difficult.”
Despite her strong belief that many funds would be better served increasing allocations internationally, Trafford Walker stressed that timing was everything.
“You don’t want to go hell for leather,” she said. “The timing needs to be right, and that means that when it comes to re-weighting super allocations it is far better to move slowly over time. The need to move quickly arises only if you perceive a huge risk.”
And if international markets are where super funds should be looking for returns next, it seems Australian funds do not need to look very far to find opportunity. David Wright, director of Zenith Investment Partners, recently tipped the strong economies of China, India and Japan to be the markets likely to perform well into the future, and also said investors needed to be wary of volatility.
For Trafford Walker, strategy is the key.
“The China and India markets are a new area for investment and, as such, are definitely attracting large interest,” she said. “However, it is important to realise that just as there is a lot of money to be made within these markets, there is a lot of money to be lost as well.
“Unfortunately, it is a case of ‘learn as you go’, and funds need to discover the answers to two key questions before they can be successful. How do you do it? And who do you link up with to do it?” she added.
Interestingly, Bye is far less inclined towards the Asian growth markets, stating that high levels of volatility coupled with lower quality information and corporate governance made investment in such areas risky.
“Credit Suisse is far more interested in the major markets to be found in Japan, Europe and the US,” said Bye. “Particularly Japan, where you can gain far better valuations.”
Bye said the economic growth that world markets were experiencing was spread broadly and this would serve to prolong the currently favourable economic cycles throughout international markets.
“A lot depends on what kind of timeframe a super fund is interested in,” he said. “If there is volatility, as is the case with the China and India markets, then timing is difficult with the P/Es so high. On the other hand, the major markets are a good option to buy in now and we think they will continue to be a good option for the next 12 months and on up to five years.
“With growth companies looking undervalued, we see the value companies as being far more highly sought after,” finished Bye.
Trafford Walker argues that investment offshore is less about timeframe and more about how it is done.
“Funds will always look to extend themselves to the longer-term view,” she said. “But the challenge is to ensure that they look after people today as well. Many funds may look at international investment from the perspective of medium or short-term strategies, but it isn’t so much about timeframes. It is much more a case of how to do it rather than for how long.”
Bresnahan stated that he saw a need to assess the global growth markets of the Asian region from a risk/reward position.
“Obviously, funds always have to keep their members front of mind,” he said. “So when it comes to altering allocations to international equities, particularly to volatile markets, it is essential that they ensure there isn’t too much impact or things do go pear-shaped.”
That said, Bresnahan added that he did see increased allocations to international equities as being inevitable over the next decade.
“The sheer weight of money to be found in Australian super funds means that this is a must,” he said. “Australia represents around 2 per cent of the world market, and the options are already being exhausted. Homes need to be found for superannuation monies, and they will have to be found internationally.”
Just as the questions of market volatility and overall international strategies have always been cause for fund caution when looking offshore, a lack of familiarity and information has also been a source of hesitation. Moving forward, however, Trafford Walker believes this must become less and less of a concern.
“Information flows have increased dramatically over the last five to 10 years,” she said. “But this is certainly a challenge for funds and their investment managers. Australia is such a long way from anything and that makes it very difficult to feel close to offshore interests.”
Trafford Walker added that funds needed to be conscious of the need to globalise, but also said there was a great deal of interest in Australian business worldwide, making the process easier.
“It is very important for funds to develop a rapport with their investment partners offshore, and executives need to be very conscious of this,” she said. “More often than not, that means a lot of travel overseas to meet with managers and look at new areas and so on. It may even mean office establishment, but there are many opportunities to do this kind of thing.”
Bresnahan admitted that information has been a problem in the past within global investment, but said a lot of the responsibility fell back on asset consultants.
“Overall, there probably needs to be even more due diligence,” he said. “Asset consultants need to be diverse in their coverage, and if this is not the case then funds may need to use multiple consultants.
“As with any investment opportunity, however, the challenge is to make it worthwhile, and quite often more resources are required to ensure this,” finished Bresnahan.
With so many industry experts pointing to globalisation as being a large part of investment in international equities, it seems logical that as this trend increases so too must the popularity of these global markets.
Bye said it was difficult to know where international equities would lie within Australian fund allocations into the future.
“It is difficult to predict what proportion of allocations international equities might account for,” he said. “But it is certainly possible that this portion will increase. Regardless, and just as is the case now, it will always depend on valuations at any one time and, of course, the other asset classes.”
Asked whether the risks associated with global equities and the timeframes so often assumed to be necessary meant that investment offshore would always be an aggressive move, Bye’s response was firm.
“Funds need diversification and diversification, in itself, is defensive,” he said. “Over the last few years the Australian economy has undoubtedly been driven a great deal by growth in the Chinese economy. If that growth disappears, then obviously Australia and Australian stocks are going to feel that. Why would you have all your eggs in one basket?
“On the other hand, there is a great deal of information and liquidity available in the major offshore markets of the US, Europe and Japan,” pointed out Bye.
Trafford Walker also sees options offshore that do not need to be aggressive.
“Absolute return strategies are more defensive,” she said. “And funds can be looking at core property and bonds as well. Typically, funds will be going offshore for growth, but there are definitely options available with which people can hedge their bets.”
For Trafford Walker though, international equities are definitely an investment for the future.
“Asia is quite close to Australia already,” she said. “But advances in telecommunications have also been enormously positive and have meant that constant contact is very possible. We already have clients with allocations that are spread 50/50 between global and domestic equities, and it is very possible that international equities will account for an even greater percentage than that into the future.
“But on the other hand, the tax advantage to be had for Australian funds investing in Australian equities are a very real incentive,” added Trafford Walker. “And funds will always need to look at valuations.”
Long-term future aside, there are certainly events of more pressing concern to both international equities and Australia’s domestic market. The key risk at the moment, particularly following this year’s brief Shanghai market fall, appears to revolve around a US market fall. The question raised by most experts is twofold. Will that landing occur and will it be hard or soft?
For Bresnahan, that risk is certainly a concern.
“The risk of that fall always lingers; it never goes away,” he said. “Funds have done extraordinarily well with their allocations to date, but there has got to be a blip on the radar somewhere. The catch is, no one knows where.”
Trafford Walker said a US market fall was always a concern and it was always being taken into account.
“Funds, asset consultants and managers always need to gauge that risk and wait for the right opportunities,” she said. “Currently, we think that risk is pretty low, but we are very conscious of how remarkable that China fall was. With allocations for funds being so critical, we are acutely aware of the need to be vigilant.”
“That risk might be more present now,” added Trafford Walker. “But life is full of risks.”
