The evolution of global investing

20 years ago, many Superannuation, Pension and Endowment Funds in Australia were running asset allocations of close to 40% to Australian Equities, exhibiting a case of extreme home bias. This structural bias was driven by familiarity and understanding with the local environment and market ecosystem as well as Australia’s system of paying high dividend yields and franking credits. The Australian Equity market and the AUD spent much of the first decade of this century in appreciation mode (AUD peaking in 2012 after a GFC induced sell-off in 2008), fuelled by rising commodity prices and higher interest rates compared to the rest of the developed world, while having a AAA Sovereign rating. This provided a somewhat cyclical vindication of the home bias adopted.

During the decade from 2011-2020 however it has been a different story. Asset allocation to Australian shares have dropped to as low as 10-20% in a typical Balanced Fund risk profile as a reaction to a weakening AUD, fuelled by lower commodity prices as China’s growth slowed. Additionally, Australia’s weakening growth has reduced interest rate cycle has eroding its prior yield advantage.

As an evolution, over the last few decades (particularly the one just past), investors have sought increased exposure in Global Equities, driven by a strong US market as well as additional exposure to areas like Asia where accessible. This is evident from the changed in weights in the MSCI ACWI in the chart below:

Regional Changes

Source: MSCI

The key takeaways in the chart above are the increase in market cap of US and Asia ex-Japan, which has taken share from Europe, UK, and Japan. This intuitively makes sense as the US has evolved as a melting pot of the world’s best companies, with exposure to global consumers and Asia the fastest growing region, with several companies emerging and growing on the back of strong fundamentals.

In the upcoming decade, we expect growth to become an increasingly scarce commodity. With technology advancing so quickly and supply chains evolving the industries where growth will occur will be those which can adapt and invest for the future. Whilst the link between GDP growth and earnings growth can be spurious, over the longer-term they have linkages. Given the fundamentals of China and India we would expect greater GDP growth, corporate opportunity and market capitalisation increases in Asia over the upcoming decade. From a valuation standpoint the US share markets (market cap) are now 1.8x GDP, compared to India and China which are both below 1.0x.

Whilst in developed economies, growth is predominantly driven by market share changing hands i.e., retailing to e-tailing, discretionary to technology, B2B to B2C, in Asia in most cases it is about the potential growth in the size of the market rather than market share changing hands.

Sectoral Shifts

Source: MSCI 

Weights in MSCI All Country Weighted Index sectors have been relatively cyclical over time. Capital more often tends to get invested at peaks of cycles rather than troughs unfortunately. The big winners in the last decade have been Info Tech, Communications, Consumer Discretionary and Healthcare. Capital is looking to be allocated in these industries given extrapolation of their growth and demand. Whilst this could be true, the markets have realised the opportunity somewhat and priced accordingly. Many investors are now overweight in these consensus growth sectors.

The losers over the last decade have been Energy and Materials, Financials. Both are seeing lower investments dollars at present (except for area of Renewable Energy). Several materials related industries have collapsed production given it is uneconomical. Investors are discussing the bringing forward of peak oil demand and financials have been brutalised twice in the GFC and during COVID. In Financials interestingly, the developed world has seen a contraction post the GFC. However, in countries like India, financials have increased significantly in their market cap given significant growth via increased financialisation and thus in the overall market size rather than market share simply changing hands, as we highlighted earlier (i.e. rising growth for all players!).

Looking Ahead

The nature of investing is cyclical over 5 to 10-year periods, with structural changes more evident over longer-term periods and quite often with the benefit of hindsight. In this context we expect to see greater flows towards Asian markets and perhaps towards cyclical industries with low investment in capex such as Energy, Materials, and Industrials – especially given valuations. When we look at the evolution of global investing, Australian institutional investors have evolved over time as follows:

Whilst most investors focus on Technology, Consumption, Healthcare and Communications, it is best not to suffer from immediate period bias and blend between secular changes and cyclical shifts. History shows us that not all changes are secular. It is our view that investors should seek to understand evolution rather than be reactionary. A long-term thought process therefore becomes the most critical aspect of being a successful INVESTOR.

A word on Active or Passive, Global or Local

An important point for investors to note is that during periods of significant market returns, passive investing comes to the fore. Investors focus on absolute returns and making money rather than relative returns and identify lower fees as a more important area than identifying skill. The trade-off between active and passive is as cyclical as other issues we have contemplated.

It is our view that focus will now shift towards broader market participation rather than narrow concentration of returns in a few companies. This tends to happen when interest rates are lower and cost of capital makes funds more accessible. This is typically an environment where good active managers skills come to the fore as they are able to identify shifts in the pattern of growth or turning points.

Additionally, when investing in markets which are unknown it is always better to access via active managers with a local presence and understanding of the ecosystem which they operate in. This is particularly the case where evolution of the economy, markets, regulation, politics, and corporate environments are in a constant state of dynamism.

Investing in markets like China and India, as flagged above, require not simply active management, but also local insights and knowledge and a continuing commitment to investor education on the virtues of being a long-term portfolio investor.

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