Understanding the investment mandate should be the starting point when assessing any fund but, says Gill Hutchison, this is all the more important when reviewing the 'patchwork of possibilities' in the IA Global sector
The Investment Association's (IA) Global sector is not an easy one to chew through, featuring as it does around 250 funds. Stripping out the income-oriented funds to form their own sector in 2012, IA Global Equity Income, eased the fund selection task to a degree but, nevertheless, if choice is what you want, you certainly have it here.
Reinforcing this point, the SRRI (Synthetic Risk and Reward Indicators) scores shown in the key investor information documents of funds in this sector range between 4 and 7, which in itself speaks volumes about the diversity on offer.
Any collection of funds that has a multi-region and multi-currency remit is bound to deliver a wider range of outcomes. While there is a high degree of directional correlation between equity markets around the world, total return numbers clearly vary considerably for different markets over different time periods.
We need only look at the IA sector average returns for different country and regional sectors to see this. Over five years, the median return for the UK All Companies sector is around 76%, Europe excluding UK is 86%, Asia Pacific excluding Japan is 66%, Global Emerging Markets is 44% and Japan is 73% (source: Morningstar, to 30/09/16, in sterling terms). Of course, most markets have been outclassed by US equities over this period, with the IA North American sector averaging a five-year return of 125%.
One of the simplest reasons why global equity funds can struggle to keep up with their indices is they often have underweight allocations to the US equity market. With the US representing around 55% of global equity indices, this does not come as a surprise.
After all, with a global opportunity set, why would you want to restrict more than half of your capital to a single market - albeit a very large one - and, in the process, suppress the benefits of diversification? Data from Morningstar indicates that well over half of funds in the sector are underweight the US.
Added to this, fund managers who have the luxury of a global palette from which to choose have the further challenge of the US's ‘perma-valuation' premium. Today, the valuation headwind is as strong as ever and the main US market resides in "overvalued" territory, according to Ned Davis' research, on the basis of the median price/earnings ratio.
In passing, it is worth noting the firm's long-term analysis suggests it tends not to hang around in "overvalued" territory for very long. Anyway, other valuation metrics show a similar picture - earnings yield, dividend yield and cashflow yield are all well below median levels, indicating higher than average valuations.
Asia and emerging market allocations
The extent of managers' involvement in Asia and emerging markets has also had an important influence on performance over the years - both for good and for bad.
In earlier years, an overweight allocation to Asia and emerging markets was often a way of adding a performance boost to a portfolio, but recent years have been tougher, with country specific problems and the big macro-economic headwinds of a strong US dollar and weak commodity prices weighing upon fundamentals and sentiment.
This year, fortunes have shifted, with investors attracted by cheaper valuations and recovering commodity prices, coupled with a desire to allocate away from the troubled European region.
As well as country allocations, funds can also vary by dint of market capitalisation exposures and style biases. In aggregate, mainstream global funds have a tendency to be overweight in mid-cap stocks, a proclivity that is true of many funds across different sectors. Furthermore, there are more growth-biased funds than value-biased ones in the sector - again, a characteristic that is common to most other sectors.
Dividing the sector into smaller groups, we see the main categories as:
* Larger-cap, flexible: Those funds that are designed to perform competitively across a wide range of market conditions.
* Growth: There can be different flavours of growth styles. They can be in the mode of seeking growth together with high quality, whereby the sustainability and longevity of growth is the driving force. Such funds may be larger-cap in nature compared with peers, given the preference for well-established businesses with strong market positions. Alternatively, they can be funds seeking a higher growth trajectory, for either structural or cyclical reasons. Such funds often have a mid-cap bias, given the overt search for elevated growth levels that can be elusive in larger-cap companies.
* Value: There are relatively few ‘true value' funds in this sector. Deep value investors often plough a lonely furrow and, in reality, few managers have the fortitude to carry the burden of contrarianism. Very often, they are run by experienced managers who are well-known for their distinctive approaches and have loyal investor bases, who are accustomed to extended periods in the performance wilderness, but who also know that the rewards can be significant over the long term. We would also note that, in this short-term performance obsessed world, fund management companies have a diminished appetite to support such strategies.
* Global smaller companies: The Global sector features a small cohort of funds that are focused upon smaller companies. They have typically performed relatively well over time, albeit with the potential for greater volatility.
* Sector equity: Sector equity funds used to be located mainly in the IA Specialist category but the global nature of their sector-specific mandates led some to be reclassified into the Global sector. Sector funds featured in the Global sector include global energy, global resources, global infrastructure, global healthcare and global consumer brands. A number of ethical/sustainable funds are also featured.
This patchwork of possibilities explains the huge range of performance outcomes for funds in the sector. Looking over five years to 30/09/16, the difference between the best and worst-performing global equity funds is around 140% (excluding sector-specific funds).
The median return of the sector is skewed by the presence of the dedicated sector funds, which are often seen at the top or the bottom of the performance table. It is unlikely to be a shock to hear that the worst-performing funds over five years are the energy and resources funds, while a clutch of healthcare funds feature towards the top.
Rich choice of global mandates
In assessing any fund, an understanding of its investment mandate should always be the starting point, but this is all the more important when reviewing the Global sector.
A fund's style bias, market cap bias, geographical restrictions and preferences all have a material impact upon risk and return and understanding a fund's particular stance is the key to identifying when it is likely to thrive, and when it is likely to struggle.
Gill Hutchison is head of investment research at The Adviser Centre. To access the firm's free-to-air fund research and consultancy service, please click here
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