There’s a whole world out there

With golden soil and wealth for toil, Australia's equity markets have long provided returns to satisfy local investors, but the decline of the mining and resources sectors mean there is a need to look for opportunities offshore.

Throughout the noughties the Australian stock market outperformed the MSCI World index, with the nation's major financial institutions shielded from the worst effects of the Global Financial Crisis (GFC) and its minerals and resources sectors reaping the benefits of China's lust for coal and iron ore.

Nature's gifts no longer deliver

However, having enjoyed the benefits of the mining boom the sector's decline highlights the need for investors to spread their equities allocations into the global market, Tempo Asset Management principal, Joe Bracken, said.

"The things that really drove the Australian stock market to outperform the world and in particular commodities - commodity prices basically through those times ballooned, iron ore went from $40 a tonne to $140 to $150 a tonne, so you have a massive explosion in demand for commodities," he said.

"Australia was incredibly well placed to supply that to its largest customer, China, [and] that really drove the stock market.

"Unfortunately, now commodity prices have clearly come off the boil, most forecasts looking [for] long-term for things like iron ore look to be more like $80 a tonne, rather than $140, so people need to dampen down their expectations of what the Australian stock market will do relative to other more diversified global markets."

Constrained by the dollar

Allied to the impact of falling commodities prices, Australian equities have been adversely affected by the strength of the dollar, which has built the case for investors to increase their allocations into global markets, Fiducian investment manager, Conrad Burge believes.

"Australian investors have a heavy domestic bias, but it is really important to have diversification, and international exposure is extremely important," he said.

"One of the things to keep in mind in that context is the fact that the Australian dollar is relatively high at the moment¬ it's gone from around 68 cents to the US dollar to over 76 cents.

"This would be concerning the reserve bank - and it should - and I would be making the case that the Australian economy has been struggling for quite some time to be internationally competitive.

"If we look at many of our competitor economies around the world, they understand this issue and they're doing all they can to maintain international competitiveness by targeting lower exchange rates¬ that's clearly something we haven't done and it's clearly been damaging to the Australian economy for quite a few years."

We recommend having at least some of that external equities exposure unhedged - because it's a really good natural diversifier for your overall portfolio. - Kathryn Young

Morningstar associate director and research manager, Kathryn Young, echoed Burge's currency concerns, and recommended to seek to gain international exposure to manage currency risk.

"We recommend having at least some of that external equities exposure unhedged¬ because it's a really good natural diversifier for your overall portfolio," she said.

"The Australian dollar tends to be a risk currency, so it tends to be cyclical, so say we get into a rough patch like we did late last year the Australian dollar tends to fall in those environments, so that means that any unhedged exposure acts as a buffer if you are in assets that are in a stronger currency at that time."

Need to diversify

Ensuring diversification within investors' portfolios has long been seen as the sensible approach to managing clients' wealth, so for Hub24 chief executive, Andrew Alcock, Australians' domestic bias over global equities has been perplexing.

Alcock noted that self-managed superannuation funds (SMSFs) have been particularly guilty when it comes to taking advantages of the diversification offered through overseas equities.

"Australia only represents 1.7 per cent of the world's gross domestic product (GDP), so it seems crazy that if there's 98 per cent of the world's GDP outside our backyard why are we not investing more than one per cent outside our backyard?" he said.

"It makes sense that investors will get exposure to bigger markets, and bigger global trends by investing overseas.

"There's certain market sectors you just can't get diversification from in Australia, like healthcare, and other things whereas globally you'll get diversification by investing in healthcare overseas."

Young said the research house backed the benefits of using global equities to take advantage of diversification in market sectors, also highlighting healthcare.

"Obviously there are some healthcare companies in Australia that also have global exposure, but there's just a lot more outside Australia," she said.

"There's some good long-term drivers you can see [in healthcare], so for example in healthcare, with ageing populations in western developed economies and they're going to need healthcare."

Best in the World

For Alliance Bernstein portfolio manager, Klaus Ingemann, allocating into global equities enables investors and fund managers to access the very best businesses in the world, rather than being restricted to the best of the local market.

"How we look at things in our group¬ we want to have full flexibility, free hands, in finding and investigating into the best stocks possible out there, whether it's an Australian stock or a US stock," he said.

"We think that opportunity set is best exploited when you have a global approach, so a good example is that if I was an Australian manager, I would probably be expected to hold an Australian bank, an Australian miner, probably an Australian telco.

"If you run a global fund you can buy the best bank in the world, you can buy the best telco in the world, you can buy the best mining company in the world.

"So you're able to capture the best companies at the right price."

Emerging styles

Alongside the need to focus on diversification, Young said that advisers and their clients needed to consider the investment style they want to pursue when it comes to global equities markets.

"We've been thinking a lot about different styles within global equities," she said.

"Of course there's value and there's growth and there's everything in between.

"Over the past few years growth has pretty noticeably outperformed value, so it's an interesting dynamic that it seems the market has really favoured sustainable growth - modest growth that seems to be sustainable and easy to foresee, so as a consequence value-type strategies have noticeably underperformed.

"We want to caution investors against selling their value strategies because they have underperformed, because it could be an opportunity for value right now.

"It's really hard to call the peaks of these types of things, so I'm hesitant to say ‘yeah value is the place to be right now,' but I believe in mean reversion when it comes to these things, so the key is don't count value out.

"That kind of factor investing has become quite popular¬ [but] you want to be diversified across styles as well as regions and sectors."

Ingemann said his team had also identified the emergence of style investing as a factor in generating returns through global equities.

"We've found that styles dominate returns," he said. "And we've also found that style are erratic and unpredictable.

"Right now low-vol strategies are super popular, and they were the best performing style in 2015, and the best performing style in 2014, but they were actually the worst performing style in 2013 and 2012, people forget about that."

Management options

With demand for global equities growing among Australian investors, advisers have been given a range of vehicles to access overseas markets, through traditional funds managers, exchange traded funds (ETFs) and new managed account offering.

For Beulah Capital managing director, Christian Ryan and Hub24's Alcock, the emergence of managed account options has been a positive development.

"As a firm, we like to [invest] through a managed account structure," Ryan said.

"Part of that is because investors like to, more and more, understand and know what they're investing in and even though you might hold all the same basket of stocks as all the other investors if you want to get out of your portfolio, it's not going to interrupt other investors that want to stay in the strategy.

"In the big unit trusts, you've got cash-flow coming in and out all the time, which either enhances or detracts from performance, but is a consideration that unit trusts have to manage."

Alcock, whose Hub24 platform and administrative solutions business has launched managed portfolios for international equities, the control investors and advisers gain through managed accounts makes investing overseas easier.

"When you have investors who like to own their own direct stock they find it incredibly difficult to access international markets," he said.

"If you want to buy stocks from around the work as opposed to just the US, you might have to open accounts in several countries, you might have to comply with different tax reporting and identification needs across those different countries, so it's quite complicated, which is probably why there's little investment in global equities.

"[A managed account] solves some of the problems¬ you could have an account with someone like us, which can trade across 15 to 20 exchanges, we handle all the issues that you'd normally have to handle by opening an account in each of those countries¬ and you can get the benefit of having a professional manager picking which stocks you should buy.

"[And] at the same time you have direct beneficial ownership, getting the benefits of your own tax treatment."

When it comes to taking on global markets, Fiducian's Burge emphasised the importance of ensuring advisers should encourage clients to use professional fund managers.

"In my view advisers certainly shouldn't be recommending that investors try to pick their own stocks," he said.

"That's always a mistake in my view, and I think they should be using professional fund managers and be as diversified as they can be."

Morningstar's Young also backed the role of fund managers.

"The beauty of actively managed funds is that with so many markets and so many currencies to keep an eye on, we think that a good active managed fund is a good place for most advisers and their clients because there's a lot of decisions to make on a daily basis and we think there's good reason to pay a skilled active manager, a professional, to make those types of decisions," she said.

"These days you can get active funds that also take emerging markets exposures - that decision between developed and emerging is a big one to make, so I like funds that help make that decision for you, as well as when to move in and out of that.

"Alternatively a well-diversified passive strategy, maybe an indexed fund or an ETF is a reasonable way to go."

While Young said indexed funds may be an option, Tempo's Bracken felt that certain indices might fail to give investors adequate diversification between markets globally.

"For people who are investing globally, if you're investing in a benchmark like the MSCI World, that MSCI World is not really the world, it's mostly the US, Japan, and the UK," he said.

"The US is very expensive and at the moment it looks like its best days are behind it, particularly with the high US dollar.

"While Sterling's not great at the moment, the UK economy will be subject to a lot of volatility this year and so for investor who are looking to invest globally, they probably want to think about a couple of other vehicles to invest in other than simply putting their money in the MSCI World, where 70 cents in every dollar is in the US and another 10 cent are in the UK."

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