While we are typically a ‘glass half full’ bunch, recent developments around the world might have left many investors feeling slightly negative in their outlook for global markets.
Let’s start with President Trump. Yes, though his policies appear to be pro-growth, the impact on the stock market of his pledge to ‘Make America Great Again’ may well be limited thanks to his protectionist stance and over-use of Twitter. On this side of the Atlantic, the UK is about to enter a hard and likely prolonged divorce from Brussels whilst at the same time the rise of right-wing populist politics across the continent challenges the very existence of the EU.
Then there is China, which having been a perennial source of bad news for global markets, has somewhat been forced to the sidelines thanks to the recent seismic shift in Western politics. There are certainly signs that the world’s second largest economy has stabilised, but bears point to the Chinese authorities’ looser monetary policy and greater fiscal spending (at a time when they are supposed to be evolving the economic model from investment to consumerism) as simply delaying the inevitable. We will leave that argument to the economists, but it is true that China’s debt to GDP doubled between 2007 and 2014 and has been rising once again over the past year.
Apart from that, the recent rally has also left equity markets on high valuations and therefore sensitive to any potential bad news. According to our research, the major equity regions (as measured by the MSCI indices shown below) are trading on higher 12 month trailing price to earnings ratios multiples than their ten and five year averages, with the likes of the US market at its highest 12 month trailing price to earnings ratio since January 2007.
Source: Morningstar
Within this backdrop, we think it makes sense to look at the global sectors in order to see what the managers who operate within it – among whom are some of the most well-resourced investors on the planet – are doing.
In this study we identify the positioning and themes that they are adopting as they face up to this most challenging of environments – including new record exposure to US equities in the wake of Trump’s election, gradually increased exposure to emerging markets after signs that the bear market in developing world equities has bottomed and widespread selling of UK and continental European equities following Brexit-related collywobbles.
Open versus closed…
Firstly, though, our research shows that closed-ended funds have much better track record of outperformance than their open-ended counterparts.
There is no denying that the global sectors haven’t been the best of hunting grounds for active managers over the years, the reason for which we will discuss later. Nevertheless, according to data from Morningstar, the average trust across the IT Global and Global Equity Income sectors has returned 127.3% in NAV terms over 10 years to the end of January compared to a gain of 124.6% from the MSCI AC World index. The average return from IA Global and IA Global Equity Income funds over that time, however, is 100%.
Performance
Source: Morningstar
Those figures don’t include survivorship bias, though when you look at the global trusts and funds that are still in existence today, again, it is in the world of closed-ended funds where you have found the greater proportion of portfolios that have delivered returns ahead of the benchmark index – as chart below shows.
Why has this been the case? Well, putting it simply, global trusts tend to be much more benchmark-agnostic than their open-ended equivalents.
Proportion of portfolios to have beaten MSCI AC World index
Source: Morningstar/FE Analytics
Greater optionality?
Our research shows that the ‘average’ global trust is far more active than the ‘average’ open-ended global fund. This is first shown by market-cap positioning, with managers of global trusts making full use of the closed-ended structure.
Over the past five years, for example, the weightings to large and mega-caps across the IT Global and Global Equity Income sector has average 52.3%. While still lower than the index’s make-up, IA Global and Global Equity Income funds have had a much higher 73.7% exposure to that area of the market.
Exposure to large & mega-caps
Source: Morningstar
This dynamic is also highlighted by the most popularly-held stocks in the closed-ended sectors, which bear little resemblance to the breakdown of the MSCI AC World. Indeed, just two of the 10 most popular stocks are also among the 10 largest constituents of the benchmark (Microsoft and Apple) and as the table shows, the average weightings to those stocks varies quite significantly to the index.
Though we aren’t suggesting that the ‘average’ open-ended global fund is a benchmark hugger, our research does highlight that four of the 10 most popular holdings in the IA sectors are top 10 constituents of the MSCI AC World index (Microsoft, Johnson & Johnson, Apple and Wells Fargo). Again though, weightings to those stocks do differ from the index.
Source: Morningstar/MSCI
This is illustrated in the average crossover and commonality of holdings in those sectors as well. Our research shows that the average crossover – by that we mean not only comparing the stocks they hold, but the proportion of assets they have invested in them – across the IT sectors is very low at just 4.35% (0% would represent no common holdings, 100% would mean identical holdings and weightings).
That figure is calculated by analysing the commonality of holdings between each member of the two global sectors with each other. An example of a global trust with low crossover with its peers is British Empire at just 0.47%. This should come as little surprise, given its long-term NAV outperformance has been driven by a distinct value style (value funds focus on stocks which are out of favour with other investors) and a predominant focus on other closed-ended funds and family-controlled holding companies.
The average crossover over among the 20 largest open-ended global funds (which account for c.60% of all the assets in the IA Global and Global Equity Income sectors) is more than double that figure at 9.95% while the average crossover across all the funds in those two peers groups is 5.36%.
This shows that while global trusts carry their own idiosyncratic risks, the average member of the IT Global and Global Equity Income sectors is far less sensitive to the movement of the index than its open-ended equivalent.
Where are global managers putting their money?
First and foremost, weightings to North American equities are at their highest in five years – despite the fact US equities are trading on their highest 12 month trailing P/E ratios over that time. However, global managers haven’t gone ‘Trump-crazy’, as weightings to the US have been steadily rising since January 2012, rising in part because the valuation of existing holdings there has been going up, but managers have not been trimming back.
The fact that North America makes up such a big proportion of the index (and therefore being overweight US equities is a tough ask) is a major reason as to why active managers have struggled in the global sectors (only 37% of global trusts have beaten the benchmark over five years), as it’s been a period when US equities have significantly outperformed the MSCI World ex USA index.
The average weighting to North American equities in the open-ended sectors is near its highest level in five years at 45.6% – though the average weighting over the past five years has been 40%, which would partly explain why there have been a greater proportion of global funds that have beaten the MSCI AC World index since January 2012 (43.6%), but the average weighting among closed-ended funds is much lower at 26.9%, and considerably lower than the MSCI AC World index’s weighting at 56.3%.
On this basis should Trump be as mad as his Twitter feed makes him appear, and if this spells bad news for US equities, closed-ended funds are less exposed to that than their open-ended counterparts, but on the flip-side they will not keep pace with more heavily US exposed funds if his administration keeps him under control and his pro-growth policies result in a boom for the region.
Weightings to North American equities
Source: Morningstar
Another area that global managers have been upping their exposure to is emerging markets, which flew back into favour last year following signs of stabilisation in China and a recovery in commodity prices.
Global managers had been reducing their exposure to emerging markets between 2012 and 2015 as developing world equities fell increasingly out of favour, however (buoyed on by share price appreciation following another painful sell-off), the overall weighting across the IT sectors has spiked since last January – with the average global trust now overweight emerging markets relative to the index. Though open-ended funds have generally increased their weightings to developing world equities, it has been by a far smaller extent.
Weightings to global emerging market equities
Source: Morningstar
This move has happened across the board, with allocations to Middle East and Africa, emerging Asia, Emerging Europe and Latin America all having risen sharply over the course of 2016.
There also is anecdotal evidence that this is part of a longer-term trend, with Scottish Mortgage’s James Anderson recently noting that there has been (and will continue to be) a shift among investors from the ‘Atlantic Seaboard’ to more innovative areas of the global economy such as Asia Pacific and the West coast of the America, while Witan – another powerhouse in the peer group – has announced that it is adding emerging markets to its official benchmark this year.
Which areas are global managers avoiding?
Given that information, you have probably guessed where global managers aren’t putting their money.
Average weightings to UK equities have fallen by close to 10 percentage points over the past 12 months in the IT sectors, with Brexit-uncertainty undoubtedly a major driving force behind those moves. In November, the average UK exposure across the two peer groups fell to its lowest level in five years.
Nevertheless, and this is something investors who want genuine diversification from their global fund should be aware of, global trusts are still – on average – significantly overweight UK equities relative to the MSCI AC World index (15 percentage points, according to our research) despite that recent trend, meaning that the likelihood of stock overlaps with portfolios in the UK All Companies and UK Equity Income sectors is high.
Weighting to UK equities
Source: Morningstar
Developed Europe has also entered ugly duckling territory, with the average weighting to Europe ex UK equities having fallen consistently over the past three years (from 17% to 13%). That is again understandable, given the raft of elections taking place on the continent over the next year. These two trends, along with a clear distaste for Japanese equities, has meant that weightings to non-North American developed markets in the global sectors are now at their lowest in five years.
Only time will tell as to whether these regional shifts will pay dividends, indeed the fact that global managers (both in the open and closed-ended sectors) have been avoiding UK and European equities like the plague could cause the alarm bells to ring for more contrarian investors. However, that aside, we have recently profiled global trusts that have helped drive these regional trends.
Mid Wynd International, for example, has been generally increasing its exposure to US equities – a movement that has been driven by the team’s valuation and thematic process. Managers Alex Illingworth, Simon Edelesten and Rosanna Burcheri note that their valuation models pushed them away from certain dependable growth names such as Nestle in the middle of 2016 and into areas such as US banks and also and onshore US oil frackers.
Then there is Monks, which has been gradually increasing its weighting to emerging markets. This has been generated by the managers increased exposure to their ‘rapid growth’ bucket, which includes existing names such as Alibaba and Naspers as well as new entrants to the portfolio such as Ctrip.com International, which given its dominant market share, is benefitting from increased online travel within China.
We will also be covering Securities Trust of Scotland, which has been severely reducing its exposure to continental Europe and the UK over the past year.
