Cross the seas for opportunities

There is consensus in the funds management industry that despite the volatile times, Australian investors must invest in global stocks to grab opportunities beyond minerals and banks, Malavika Santhebennur writes.

There has been no shortage of political upheaval and uncertainty in the Western world, with the election of US President, Donald Trump, the imminent exit of Britain from the European Union, and the increasing appeal of France’s National Front leader, Marine Le Pen in the upcoming presidential elections in France this year.

Trump’s proposed economic agenda along with theconciliatory tone in his address to Congress in February, which investors described as “presidential”, resulted in record high rallies in US stock market indices in March despite the lack of detail on his economic agenda.

However, the market is perhaps stepping back and re-evaluating its optimism after Trump failed to replace Obamacare. 

Antipodes Partners’ deputy portfolio manager, Sunny Bangia said that while there was enthusiasm and reflation rallies on the back of Trump’s proposed economic agenda, he warned the market may have leapt ahead of itself in the short-term, particularly in anticipation of Trump’s ability to pass legislation.

“It’s never that easy in politics. Yes US markets could be in a way vulnerable to disappointment for sure given the quick fire rally we’ve had in a short space of time,” Bangia said.

“So that’s definitely the case that we could have a little bit of disappointment: Trump bump turning into a Trump slump.”

A number of fund managers believed stocks were overvalued, according to a Bank of America Merrill Lynch monthly survey of 200 global investors representing almost $600 billion in assets under management, with 34 per cent of managers expressing this view in March, up from 26 per cent in February.

Almost half of all respondents said they were overweight stocks in their portfolios, with the bank’s global research chief investment strategist, Michael Hartnett saying investor positioning called for a risk rally pause in March/April as allocation to equities were at a two-year high and bond allocation was at a three-year low.

Perpetual global equities portfolio manager, Garry Laurence concurred that there was a need for a pause in the rally and noted global markets had already flattened in the past few weeks at the time of writing this article.

“The market has moved pretty fast over the past three months and valuations are probably globally slightly above the 10-year average in terms of the P/E [price-to-earnings] so I won’t be surprised if the market does take a breather,” Laurence said.

He added that many stocks and sectors had re-rated and risen, with investors now waiting to see what specific policies Trump would implement in the US.

“We think that a lot of the bond proxies like utilities and property are still overvalued. We also think consumer staples are expensive. So there are a number of sectors which we do think are expensive,” Laurence said.

He also noted the market had priced-in many of the stimulatory policies proposed by Trump such as infrastructure investment, with materials and industrial stocks rallying substantially off the back of Trump’s proposal to invest $1 trillion in infrastructure.

“But we really don’t know the timing of that, whether he can get it past, how he’s going to fund it. So I think there’s still a lot of uncertainty there but the stocks have reacted quite positively to the expectations of him doing something in terms of a fiscal stimulus side,” he said.

Bangia said previous US administrations presented policies with more clarity and investors understood the administration’s stance on those policies. This was despite there being a few instances over the last 10 years of disagreements between both houses or despite the fact that the administration might not necessarily deliver growth.

“After we’ve seen the administration be in power for a few months, to be honest with you, there’s a lot of confusion, and there’s a lot of uncertainty [on] what will or will not get passed,” Bangia said. 

“And whilst we always have to deal with an uncertain world, I think when the administration is pushing an agenda and then changing it the very next week, just makes US politics very uncertain, makes US businesses uncertain in terms of investment capex and then sort of makes you realise that… it makes the European politics look quite tame in the same token.”

Limitations in Australia

In the March issue of Columbia Threadneedle’s ‘Go Global’ series of articles, the firm said Australia’s traditional investment profile was evolving as people lived longer and pensioners increasingly intended to rely on their superannuation fund to fund their retirement.

The article, titled ‘It’s time to go global’, quoted a KPMG/Morningstar study based on data collected from the Australian Bureau of Statistics, and said Australia was also in the midst of a structural shift towards knowledge-based work, such as healthcare, technology, and retail.

“However, corporate Australia has been slow to innovate. Most large companies have their roots in the early part of the last century or even the late 19th century,” the Columbia Threadneedle article said.

“In contrast, many of the US’ leading companies, such as Apple and Facebook, were founded within the last one or two generations.”

The 2016 KPMG/Morningstar study showed that while the top three US companies (Apple, Google, and Microsoft) were founded in 1976, 1998 and 1975 respectively, the top three Australian investable companies (BHP Billiton, Commonwealth Bank, and Westpac) were founded in 1885, 1911, and 1817 respectively. Apple was valued at $522 billion while BHP Billiton was valued at $110 billion. 

Noting the appeal of investing in Australian stocks due to dividends and franking credits, the paper also said new, successful companies would emerge in Australia but their early stages would focus on growth, meaning dividend payments would become negligible or redundant.

In May 2015, Morgan Stanley reported that Australia’s 200 biggest listed companies paid out 73 per cent of their earnings as dividends, compared with only 50 per cent just five years earlier. This has since grown and the 10 largest income payers comprise around 50 per cent of the total Australian Securities Exchange (ASX)income.

“Any Australian company that reduces its dividend risks sending a negative signal to stock market investors,” the paper said.

Financial, resource, and real estate companies still dominated the market in Australia but there were only 58 stocks within these sectors, with market capitalisations of more than $1 billion and dividend yields above three per cent.

Of the 22 financial companies, 15 operated in the bank and insurance sectors, which would be directly affected by continuing low interest rates.

What are the barriers?

Home bias prevailed among Australians, with investors preferring to invest in Australian equities due to familiarity, affinity, and of course, to reap the benefits of dividends.

Investment and superannuation platform provider, HUB24 launched international managed portfolios on its platform in 2015, which allows investors to directly own international listed companies via professionally managed portfolios in global markets across North America, Europe, and Asia.

Its managing director, Andrew Alcock said that while investors felt safer and better understood Australian equities and felt it was more tangible, this home bias could be denying investors the opportunities to broaden their horizon rather than having narrow exposure to limited sectors such as resources and banks.

Moreover, Alcock pointed out that investing in global equities was complex given investors would be dealing with multiple jurisdictions, countries, or exchanges with different identification and tax rules and significant amounts of paperwork.

“Typically Australians have approached this by using more structured products like ETFs or managed funds, a legal structure to get that access because the fund manager takes on that role. But those structures in themselves are arguably inefficient,” Alcock said.

But he also stressed the need to challenge this bias by finding ways to educate investors and provide them with the benefits of tangibility that they enjoyed in Australia so that they could enjoy the benefits of investing in global technology brands, healthcare, and other sectors.

“Partly, I believe that is direct investing in direct international assets because you know who Google is or you know who Microsoft is or you can understand a massive healthcare player or tech company,” he said.

Clients’ exposure to global equities should range from between 25 to 40 per cent, depending on whether they were conservative or growth investors, Alcock said.

He said buying global equities in vehicles like managed funds or exchange traded funds (ETFs) was intangible and investors would not know what they were purchasing, while they would also incur costs in those structures.

“There are broking costs and manager costs inside managed funds and when you move from one fund to the next, effectively you’re selling the units in the fund,” he said. 

“But you’re moving to another fund that’s holding the same equity so you’ve got transactions costs that are irrelevant because you should be holding the underlying asset.”

Alcock said advisers could create substantial tax benefits with global equities in portfolios in the same way that they could in managed accounts in Australia. 

“If I as an adviser can show my client how I can improve their retirement outcomes just by investing in a portfolio of stocks rather than a managed fund overseas, that’s increased my value proposition potentially by hundreds of thousands of dollars over the client’s lifetime,” he said.

Alcock said the take up for the managed portfolios service had been slow, but “understandably slow” and was within the firm’s expectations. He attributed this to advisers becoming accustomed to the new service.

“I think it’s just time. It’s people understanding this and becoming more comfortable. People are getting used to it,” he said.

“The other reason for slow take-up or reserved take-up, if you like, is it’s still complex. Even though you’re providing a portfolio across multiple exchanges there are some identification and tax processes that you have to go through.”

There were 10 international managed portfolios available on the platform, while advisers could invest directly in individual international shares across 15 exchanges.

Opportunities still abound

Despite the political uncertainty in the US and parts of Europe, Australian investors were still being encouraged to look beyond home soil and venture into global equities as they were filled with opportunities otherwise unavailable to Australian investors.

Bangia said Antipodes was attracted to Europe and some of the more domestic facing businesses in Europe such as banks. This was predicated on the fact that the Eurozone was witnessing a more broad-based recovery.

“Europe faced two back-to-back recessions so consumption was held back and that normalisation of consumption was a headwind, now a tailwind. You have exports recovering because global growth is looking better so that’s another tailwind,” Bangia said.

“Even though you don’t have the headline unemployment rate falling dramatically in the European Union, you have the participation rate rising. So Eurozone is adding quite a lot of these jobs into the workforce and that’s creating stronger consumption power.”

The labour market was not tight in the Eurozone, which meant corporates in the region were not encountering some of the wage pressures experienced by US corporates at this stage of the cycle.

Bangia said the firm was seeing interesting opportunities in firms like ING Group, which was a disruptor online banking franchise. It had a cost advantage because of the online banking model and could grow in a low growth environment but was now going to be a tailwind in an improving growth environment.

The bank had a dominant market position in the northern European markets (Benelux: Belgium, the Netherlands and Luxemburg) where people were savings rich, the countries had affordable housing markets and were in a strong economic division of Europe.

“If you think about ING Direct here in Australia which is now the sixth largest bank in Australia without one branch network. So it’s essentially a challenger bank in Australia and many other parts of the world such as Germany, Spain, Poland, Romania,” he said.

“The challenger banking franchise when you look at other challenger banks trade in Europe, we’re sort of using an average valuation of accessing clients, some of them trade on higher multiples, some of them on lower but on an average multiple of 13 times.

“If you put that multiple on ING’s challenger franchise which is about a third of the business, the rest of the franchise, which is Benelux, is on seven times’ earnings, which is at a decent discount to the actual average European bank key multiple which is about 10 to 11 times earnings.”

Laurence said a number of Perpetual’s positions were in Asia ex-Japan in the technology and healthcare sectors. The firm has particularly focused on online advertising and services, and invests in US-listed Chinese online employment classifieds leader, Zhaopin, of which Seek owns more than 60 per cent. The firm also owns Chinese car website, Autohome.

“So we generate a lot of online content around cars and then have a lot of auto dealers that advertise on their portals and auto manufacturers,” Laurence said.