Diversification in portfolios is crucial to getting good returns, says Adrian Stewart. He explains why investors should look beyond Australian shores in order to capitalise on global opportunities.
When we look back over the past few years in financial markets, the fact that we have seen some major upward and downward swings goes without saying.
While one of the major focuses locally has naturally been on how Australia, also known as 'The Lucky Country', has fared during this period compared to its global counterparts, the start of 2011 might present an opportune time for advisers to take a step back from client portfolios and assess whether they are truly as diversified as they believe them to be.
Typically, Australian investors will have large exposures to the Australian market.
This makes sense, as few would disagree that Australia has proved itself to be a sound investment during recent years when compared to elsewhere.
However, as you will also be aware, due to the nature of our nation and its natural resources, the Australian market is largely made up of two sectors.
Materials and financials now dominate more than 60 per cent of the Australian Securities Exchange, driven by both strong continuing demand for our resources from places like China and India, and a continued boom in the price of Australian residential property.
Let’s look further at China as an example. Beijing has a population of more than 22 million and its growth has required a huge emphasis from local government on infrastructure.
For its train system alone, it aims to have 561km of track in operation by 2015.
That requires a lot of resources, from steel to iron ore, a great deal of which will come from Australia. Right now, China uses more than 21 per cent of Australia’s exports.
Further to this sector concentration, just five companies from these two sectors have contributed almost 90 per cent of the returns from the Australian market during the past decade.
Another interesting fact is that the top 10 companies in the ASX200 make up more than 51 per cent of the market weight.
What this can leave an investor with is a portfolio that may look diversified, but is in fact highly concentrated in just a few sectors.
So what might the solution be? In my view, that lies in having another look at global equities and looking beyond the negative news we might hear out of certain areas to see the companies that lie underneath.
These may hold fruitful investment opportunities for Australians.
Global markets offer investment opportunities that cannot be accessed through the Australian share market and can provide important diversification, as well as exposure to some key global themes, which will see significant demand growth during coming years.
Consequently, companies that participate in these areas should be set to flourish.
Unlike the Australian market, the MSCI World is not dominated by any sector or company. In fact, no one stock makes up more than 1.5 per cent of the entire market.
I am of the firm view that global equities may offer compelling long-term opportunities, especially during volatile times.
And while identifying the best way to access them and select which companies have the potential to generate the more compelling returns can be challenging, there are avenues out there that allow you to leverage the expertise of others to assist your clients in seeking to meet their long-term investment objectives.
Let’s look at some of these investment themes in more detail. Firstly healthcare, and for this we turn to the US.
Much has been debated within the media about the growing issues with poor diet and lifestyle in the US, which has led to an increase in health-related issues, specifically diabetes.
In 2007, 23.6 million children and adults in the US, which is 7.8 per cent of the population, had diabetes. Further to this, in the US 1.6 million new cases of diabetes are diagnosed in people aged 20 years and older each year.
This is a considerable number.
Danish pharmaceuticals company Novo Nordisk is the world’s largest supplier of insulin and related products. It has product facilities in seven different countries and distribution capabilities in 179.
As an investment, the company has provided a one-year return of 77 per cent to its investors and provides an operating margin of 29 per cent.
Its earnings per share have grown at an average 18.8 per cent per annum during the past five years.
That, I believe, is an attractive investment in anyone’s book and it's not exposure that could be achieved from the Australian market.
Next we can look at the shift in lifestyles and wealth of those in emerging markets like India and China. With the population shifting from rural areas to cities in the search for work and a better lifestyle, wealth is increasing and so, therefore, is the demand for higher quality goods.
For example, this has meant that automotive penetration has expanded in these nations, as has computer usage.
This leaves global companies like Microsoft, Hyundai and Canon well positioned to take advantage of the increase in demand for their goods and services.
Japan-based Canon is a good example of a truly global company, which currently generates more than 78 per cent of its revenue from overseas.
So, while the investment opportunities may now look more compelling for your clients, how best to access these opportunities is another question we need to tackle.
While many may be put off global equities because of the return of the broader market as a whole, when we look back over this performance again, despite the high levels of market volatility, we can clearly see the emergence of winning and losing companies.
Some of these I have highlighted here. This further demonstrates the importance of good stock selection when considering global equities.
However, good stock selection can be a challenge in itself due to the deep company analysis and understanding of the various geographies, investment themes and companies available that is needed.
Therefore, utilising the help of a fund manager that has earned a reputation for its expertise and proven track record can help.
Here, there is also a compelling argument for choosing an active manager.
While the volatility in global markets has had its impact on investment managers everywhere, I would argue that the nature of active management appears to have enabled certain fund managers to continue to perform well and select quality global companies, protecting investors’ capital during market downturns and capturing the gains during upswings.
So although we certainly do live in ‘The Lucky Country’, and we should all be proud of how our financial markets have fared compared to others during recent years, for me, 2011 presents an opportunity to reconsider global equities as an important diversifier and way to bring added value to client portfolios.
Adrian Stewart is head of distribution at Macquarie Professional Series.
