Looking at data in Morningstar Direct, we note that three years ago there were around 1,300 funds in the Morningstar Global Large-Cap Blend Equity category (the largest and most popular grouping within the Global categories) and this figure has risen to over 1,500 funds today.
This trend is in keeping with the increasingly globalised world we live in and suggests that investors are increasingly focused on trying to select the best opportunities across the world, rather than concentrating on diversification with regional equity funds. It does, however, also raise doubts and question marks about the viability of the theory of de-coupling markets often touted among investors in the past.
The past few years have certainly put paid to this notion for the time being, and many now accept that while economies may de-couple, stock markets, influenced largely by the flow of money, are unlikely to.
While the direction of returns across markets has been similar, it has been differentiated by the magnitude of the performance. Over the last ten years to the end of July 2012 the MSCI Emerging Markets Index is up 370%, compared with the MSCI Japan Index, which is only up 89%. Funds that have typically held significant emerging market overweight positions have naturally benefited from this trend and from a broad perspective this – more than style or market cap – has been the dominant driver of fund performance over this period.
Morningstar categorises global funds into five broad categories, namely global large-cap blend, global large-cap growth, global large-cap value, global flex cap and global small cap. Over the last three and ten years the average return in all the large-cap categories has been similar, suggesting that a style bias per se has not been a meaningful contributor to fund performance.
Funds to watch Three Year Performance
The Morgan Stanley Global Brands Fund is managed by a team of seven, all of whom form part of the international equity team. It is unsurprising, given the fund’s significant bias to consumer staples, that it has performed well in a market that has broadly favoured the more defensive areas. The team’s overriding philosophy is based on recognising the importance of quality and compounding at the right price. To this extent, they seek to invest in great businesses at compelling valuations. The team takes a long-term approach and is primarily focused on investing in businesses they believe will deliver a strong absolute return to investors. Their approach is bottom-up and in-depth,with the primary focus being to identify companies with difficult to replicate intangible assets, high free cash flow, repeatable businesses, sustainable high ROCE and strong management.
Rajiv Jain (pictured) has managed Vontobel Fund Global Value since its inception in 2005. Jain, who joined Vontobel in 1994,also manages an emerging markets portfolio for the group and assumed responsibility for international equity portfolios in 2002. He has been assisted by co-manager Matthew Benkendorf since 2008. The theme of durable, defensive businesses persists among the top performers over three years, with the managers also seeking to invest in high-quality businesses which show strongand sustainable growth, where they feel confident predicting their earnings over the next five years.
Running a convertibles fund requires a strong knowledge of the bond markets, but detailed equity market knowledge is also needed. Building on such knowledge has helped Calamos to successfully run the Global Equity Fund. Their approach combines quantitative and qualitative research looking at the overall macro environment as well as bottom-up security analysis.Their style is deliberately growth-biased but they aim to distinguish between structural growth and cyclical growth which has helped them to perform strongly in the last few years. Nick Calamos is to step away from the day-to-day management of the fund, to be replaced by former Janus Capital CEO Gary Black.
US stocks outpace EM
As dominant as emerging markets have been in the last ten years, it has been all about North America in the last three and the MSCI North America Index for the three years to the end of July 2012 is up 145% and leading returns across markets globally.
Emerging markets have remained strong, fuelled mainly by strong performance during periods of market strength and are up 122%. Japan continues to languish at the bottom of the table with a return of 81% and, despite all the recent woes, European markets too are up 113% over this period.
For many funds, this has been a headwind as they are typically structurally underweight North America, which constitutes over half the weighting in the MSCI World Index. Broadly speaking from a style perspective, growth funds have typically had a higher North American allocation. This is largely attributable to the technology weighting which makes up around 20% of the S&P 500 Index and is home to many of today’s large-cap growth companies; it constitutes less than 3% of European and UK indices.
Apple, for example, is today the biggest stock in the world by market cap but, despite this, it is only the sixth most-owned stock by fund managers. By contrast, the most owned stocks in the large-cap blend category are BAT and Pfizer, perhaps illustrating that global equity managers are still hiding in quality defensive stocks despite the arguably high valuations.
Funds to watch Newcomers
BlackRock has tried to distinguish the BlackRock GIS World Income Portfolio from the average global income fund in terms of the portfolio’s beta. Fund manager Stuart Reeve (pictured) builds a portfolio which yields an extremely defensive beta range of 0.7-0.8. The result is a fund which has been an admirable protector of investors’ capital during downward-trending markets and volatile periods. But the flipside is that investors should be aware this sort of fund is likely to deliver less participation during bull markets.
Experienced manager Paul Boyne has run the Invesco Global Equity Income Fund since July 2010 when Invesco International acquired Morgan Stanley’s retail asset management business. Boyne is supported by co-manager Doug McGraw, who boasts over 15 years’ investment experience and had previously worked with him at Morgan Stanley. The fund aims to generate a rising level of income, together with long-term capital growth, but the duo’s approach is pragmatic and they are mindful of being completely driven by yield, as they believe this may lead the fund toward areas where fundamentals may be unattractive. The focus in this fund is on balance sheet strength and companies with strong franchises that are able to produce a return on equity sustainably higher than their cost of capital.
The Polar Capital Global Insurance Fund is co-managed by Alec Foster and Nick Martin. The duo are experienced investors; Foster has over 40 years’ experience in the insurance sector and has managed the strategy since its launch in 1998 as the Hiscox Insurance Portfolio. It appears in the newcomers list because it was relaunched in Polar Capital’s name following the group’s acquisition of HIM Capital in 2010. We have a high opinion of the managers’ ability to harness both their in-depth knowledge of the broad insurance industry and their established portfolio construction skills to build a relatively concentrated portfolio of high-quality companies that are well-positioned to deliver an attractive return over the longer term. Despite the concentrated stock list, they seek to ensure diversification across different types of insurance and their approach has delivered stellar long-termperformance.
Large-cap Japan attracts
Of the large-cap categories, the global large-cap value category has unsurprisingly had the most significant underweight to North America. Looking at the funds in the category, approximately a third of the funds appear to have an income remit, which has significantly influenced returns within the sector.
In recent years, many value managers have been overweight Japan and at the sector level underweight consumer staples, both of which would have held back performance. By contrast, funds with an income bias are typically underweight Japan and overweight defensive sectors, including consumer staples – factors which have contributed positively to performance.
Volatility is not going away
Interestingly, despite the volatility and investors’ negative sentiment, markets have actually gone up considerably this year even though the general perception has been negative. Looking ahead, we believe that further equity upside is still probable but markets will likely remain volatile and, to a large extent, highly dependent on policymakers.
A strong rebound is possible if further positive support from the ECB/EU is forth- coming but stock market gains will remain constrained in a low growth, low inflation phase for some time to come with deleveraging still a long-term challenge for the developed economies.
One potential source of strength is that government bond yields are now so low that pension funds and other institution- al investors are questioning their commitment to government debt. Alongside increased buying of investment grade corporates, institutions will also likely focus on credit substitutes (i.e. high quality, high yield stocks). A potential source of weakness, however, is further earnings downgrades.
Funds to watch Assets under management
The Veritas Global Equity Income Fund is one of our highest-rated global income funds with a Morningstar OBSR analyst rating of gold. Managers Charles Richardson and Andrew Headley focus on total return in addition to yield, in order to build a concentrated 30-stock portfolio. The team focuses on stocks they believe have durable competitive advantages and sustainable cash flows. They look for stocks capable of providing a 15% annual return over three to five years and estimate this using discounted cash flow analysis.
Our second pick in this box is Aberdeen Global World Equity which has a Morningstar OBSR analyst rating of silver. The Edinburgh-based team behind this fund look for companies displaying quality and value traits and this yields a portfolio with large stakes in the so-called defensive sectors such as healthcare and consumer staples.
Another silver-rated fund from this list is Orbis Global Equity.The fund manager William Gray and his team have managed this fund since its launch in 1989 – a long track record that is rare in the often fickle fund industry. Orbis believes long-term returns can be produced by identifying shares which are priced attractively relative to their intrinsic value. The investment approach is primarily bottom-up with a particular focus on companies with an ability to generate superior growth in cash flow, earnings and dividends.
Earnings growth will struggle
Ultimately, in the long-term, stock selection is key. But with a difficult fundamental backdrop it will be hard to generate sol- id earnings growth. In this environment, quality companies with strong cash flow and exposure to growth markets and higher yielding stocks with growing dividends, irrespective of country or sector, appear at- tractive on a long-term view.
Overall, flexibility plays to the strength of global equity managers more than any other long-only equity vehicle. Most managers are not reliant on a single region or sector. Global managers can pick and choose their stocks and sectors from one country to the next.
The flexibility afforded to global funds results in them being a sensible option for investors unable to scour separate regions to pick out the best equity managers, or unwilling to venture into the world of single-country risk. Equity income investing is another style which has enjoyed a sweet spot in recent years. Global equity income funds are one of the fastest-growing areas for asset managers and have been used by many investors as a safe-haven route to equity exposure during the market turmoil.