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Global Diversification, Global Opportunity

During the past 10 years, strong demand for Australia’s resource exports and residential property has contributed significantly to Australian sharemarket returns.  This period of strong performance has also changed the composition of the Australian sharemarket.  We consider how an allocation to global equities can offer portfolio diversification and reduce downside risk, through offering investors access to a much broader opportunity set.

Still the lucky country

For many Australians, David Horne’s famous phrase ‘the lucky country’ continues to describe everything that is great about our nation.  Depicting our weather, lifestyle and history, the phrase also emphasises our good fortune in the economic sphere.

In the economic climate since the global financial crisis, the phrase has never been more pertinent.  Australia’s geographic isolation and rugged landscape are no longer a weakness.  In fact our close proximity to Asia and abundant natural resources helped to cushion our economy from turmoil that impacted many of the world’s financial markets.  Australian equities have actually grown by 8.0 per cent pa since 2000, outperforming international equities by 11.5 per cent each year during the period .

Today Australia remains the lucky country, with an economic environment underpinned by two major growth drivers.  Unprecedented demand for Australian resources and a continued boom in the price of residential property have been the key rivers of returns in the Australian sharemarket during the past ten years, concentrating the ASX towards Materials and Financials.

During the past ten years, five companies from just two sectors, financials and materials, have contributed almost 90 per cent of the market’s returns².  As a side effect, the same two sectors now make up more around 65 per cent of the top 200 companies by market capitalisation.

Driving demand for Australian resource exports has been enormous growth coming from emerging market economies, primarily China.  Our largest export destination, exports to China grew by a third in 2009, reaching almost 22 billion Australian dollars³.  This trend is expected to continue this year, despite Beijing’s recent efforts to put the brakes on growth.

Residential property is the other key growth driver in the Australian economy.  Encouraged by government grants and tax concessions, Australians have invested more and more of their wealth, and debt, into residential property.  Australian household debt now exceeds our American counterparts as a per cent of household disposable income, and this is mostly made up of mortgages4.

Considering some of these statistics, it is important to remember that many represent major structural changes in the global economic and geo-political landscape.  Though these trends may have yet to fully play out, continued growth at these same levels is certainly not a given.

Global diversification, global opportunity

There is no doubt that in recent times local markets have proven to be one of the best places to invest.  But the high concentration in just two sectors highlights the need to consider a broader opportunity set, for the sake of diversification and risk management.

Rather than attempt to predict the future, the best investment managers always return to investment fundamentals when developing their investment strategy or decision.  This is where one of the most fundamental investment truths comes back into play: don’t put all of your eggs in one basket.

Unlike the Australian sharemarket, MSCI World is not dominated by any sector or company.  No one stock makes up more than 1.5 per cent of the entire market5.  Investing in global sharemarkets offers access to sectors that are under-represented in the Australian sharemarket, such as health care, information technology and consumer discretionary.

Truly global businesses can offer growth opportunities with broad exposure to global themes and trends.  Some of the more robust global companies offer diversified income generation driven by a whole host of different revenue drivers.  And because these companies do not depend on any singular theme or market, they are often more insulated from economic ups and downs.

Accessing global equities

When considering an investment in global equities, many investors make the mistake of associating the returns of specific stocks with the performance of the broader market.  Looking back over the past decade in international equities, poor overall performance, high levels of market volatility and a number of obvious winners and losers highlight the importance of good stock selection.

Selecting which international equities to invest in can be quite a challenge.  Few individual investors have access to the resources required to complete thorough company analysis, and make truly informed investment decisions.  For many Australian investors, accessing global equities requires selecting from a wide variety of global stock portfolios.

Although the broader global market performed poorly since 2000, there are numerous examples of active managers that performed exceptionally well over the period.  That is because the best active global equity investment managers have been able to protect investors’ wealth in market downturns and capture significant upside during periods of positive performance.

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Article originally appeared in Macquarie’s Forward Thinking magazine, December 2010.

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