Back to the Future

Back to the Future
International Investing in the 21st Century

By Chris Lees, head of global sector teams, Baring Asset Management

What would be your candidates for the best- and worst-performing equity markets this century? In spite of the fashionable hypothesis that “geography is dead,” the answer is that the emerging markets, Canada and Pacific ex Japan have consistently outperformed the U.S. and Japan. Research suggests the reasons behind this are structural rather than cyclical. The investment world today has more in common with the nineteenth century than with the twentieth. Whereas the last century was marked by nationalism and socialism, the nineteenth century was characterized by the rise of globalization and capitalization. While the Iron and Bamboo Curtains removed Russia, Eastern Europe and China from the global economy in the 20th century, the nineteenth century saw the emergence and industrialization of North America.

So far this century, we have seen a significant increase in globalization and capitalism, plus the steady industrialization of China and India, which account for more than half of the world’s population. The lessons of history from the nineteenth century can be usefully applied to investing today and this represents a sustained structural opportunity for long-term investors.

Centre of gravity
The inflection points can be seen today if you look for them. The financial centre of gravity is moving east. Not only have the Chinese authorities successfully privatized their banking system, but the Kuwait Investment Authority was the largest investor in the largest-ever initial public offering (IPO), of the Industrial Bank of China. For the first time in decades, the Hong Kong Stock Exchange did more U.S. dollars’ worth of IPOs than the New York Stock Exchange last year.

Where U.S. exchanges used to set the tone for global trading patterns, that role has been taken up by China and Asia in 2007. Asia ex Japan now accounts for 31% of the global economy, 50% of the world’s currency reserves and just 10% of global stock market capitalization. At some point that situation has to correct itself and the process has already started.

It is recommended that investors focus their global investments around the best combination of future growth and attractive valuations, namely Europe, Asia and in the emerging markets. Asian real estate is a very attractive yet under-owned asset class, and the leading Asian real estate developers are structural growth companies whose shares are structurally under-valued. The cheapest assets to be found anywhere in the world are Asian currencies. These are cheap only because they are fixed, meaning that any long-term investor should have a significant amount of their assets in Asian currencies (via equities and property). In particular, history shows that eventually all fixed currencies revalue. Indeed, it looks like the Chinese authorities have now allowed their currency to appreciate at a slow but steady rate of 5% per year against the U.S. dollar. This may not sound like much, but 5% per year compounds into a gain of over 100% in just 15 years.

When constructing international portfolios, it is important to keep in mind that top-down trends last longer than expected or predicted, allowing investors to capitalize on them once correctly identified. In looking for stocks, search for growth businesses where growth investors do not traditionally look, then construct equally weighted portfolios and let the winners run and weed out the losers. Finally you face this question: Is Samsung a Korean stock or a global technology stock? To the surprise of most investors, it still behaves more like its local market index than the global sector, a feature it has in common with most Asian and Emerging Market companies.

For most investors, “going global” would seem to be obvious, but it has a big unintended consequence. Fully 50% of the MSCI World Index is represented by the U.S., a market and currency we expect to underperform for the rest of this decade. Instead of looking at the MSCI World Index, plan sponsors who want to take full advantage of the trends and anomalies identified here should focus on the MSCI World ex-U.S. Index, given its much higher exposure to the many structural opportunities in Europe and Asia.

To view Chris Lees' presentation, click here.




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