Major developed markets, led by US stocks, are outperforming emerging markets so far this year. A key driver is the flow of foreign equity funds, out of the latter and into the former, which we highlighted last week (“Covid-19 drove global funds to developed markets”, The Edge, Issue 1384, Aug 23). We attribute this, primarily, to short-medium term economic growth divergence because of the Covid-19 pandemic — resulting from differences in their abilities to implement massive monetary and fiscal stimulus to buffer the impact and subsequent pace of recoveries that is driven by vaccination rates.
This divergence in growth outlook appears likely to persist for longer now that the US has decided to give a third Covid-19 booster shot to all fully vaccinated Americans from Sept 20. Israel and Hungary had already started doing the same earlier, while others such as Germany, France, Belgium and Austria have planned to offer booster shots to their elderly and immunocompromised patients next month. The US’ decision to broaden the recipients of the third dose to all would probably trigger a similar move in other rich countries. Incidentally, the US Food and Drug Administration last Monday granted full approval to Pfizer-BioNTech’s vaccine, Comirnaty, paving the way for more vaccine mandates. All of the above may well leave even less for the rest of the world, further delaying their economic recoveries.
Money flows to where the promise of returns is greatest, after taking into account the differences in risks. Movements of funds in and out of most countries are generally unrestricted. And statistics on institutional fund flows are readily available, tracked and collated by various data service providers such as Bloomberg and Morningstar. Though less clearly monitored, we have no doubt that “globalisation” is also happening on a smaller scale, by individual investors. It underscores the very global nature of investing today, more so than ever before.
The world has indeed become a global village, thanks to the internet and continued advances in communication technologies, which have enabled the equal, instantaneous flow of information and easy access to capital markets well beyond one’s home country.
The reasons for a global portfolio are many, primary of which is diversification, in terms of economies, currencies and their correlation. Different countries have their own strengths in the types of industries-businesses and growth outlook, offering different potential returns and risks at different points in time. In other words, a global portfolio presents significantly more opportunities to earn higher returns within the limits of one’s investing strategy. In fact, this is why we started the Global Portfolio, back in December 2017. And it was the right move.
Total returns for the Global Portfolio since inception now stands at 63.4% — well ahead of returns for the Malaysian Portfolio, of 34.1%, during this period.
One of the most interesting observations from our experience in managing both portfolios — as a reminder, these are real portfolios with actual transaction costs — are their performances relative to the benchmark indices. While the Global Portfolio has performed very well, its outperformance relative to the benchmark MSCI World Net Return Index is not big, currently about 4.9%. In contrast, although the Malaysian Portfolio has not gained as much as the Global Portfolio, it is very handily beating the bellwether indices — by 45% to 46% compared with the FBM KLCI and FBM Emas index, which fell 11.8% and 10.5% respectively over the same period.
We think this is down mostly to a combination of two factors — the rapid growth of passive funds and the difference in our level of knowledge. We knew from the outset that our data and information for a global portfolio would be about the same as the average investor. There is no meeting with management or special insights into companies beyond information that is publicly available. The slight edge we have is our experience, understanding of data, trends and analysis, and general background knowledge.
Passive funds — which simply replicate the stock composition of the index they track — have been rising rapidly in popularity in the past decade, and more so in the advanced markets. In the US, passive funds — mutual funds that employ clear passive strategy and exchange-traded funds (ETF) — as a percentage of total assets rose from 33% in 2014 to more than 51% currently (see Chart).
Empirical evidence suggests that actively managed funds as a whole tend to underperform over time, primarily because their comparatively higher fees will eat into returns on an annual compounded basis, especially in the years the funds are making losses. Still, this does not mean the end is nigh for active portfolios.
One of the consequences of the “blind” investing strategy of passive funds is that money, more often than not, goes into the same group of large-cap stocks that are constituents of the most widely tracked indices. Case in point, the two most popular ETFs track the Standard & Poor’s 500 index (SPDR S&P 500 ETF Trust) and Nasdaq 100 index (Invesco QQQ Trust). Five stocks — Apple, Microsoft Corp, Amazon.com, Alphabet and Facebook — feature prominently in both indices. They have a combined weightage of 21.9% in the S&P 500 index and 51.4% in the Nasdaq 100 index, up from 8.7% and 36.2% respectively in January 2014. In other words, these five stocks alone have a huge outsized — and growing — influence on the indices, or, as we call, it the “market”.
These are also the stocks that most investors, including our Global Portfolio, buy — for the same reasons: They are liquid, high-quality and widely researched stock with good, and relatively predictable, growth prospects. Clearly, though, you cannot beat the market by buying the market.
This crowding into the same small clutch of stocks results in a self-perpetuating positive loop in terms of share prices (market caps), returns and valuations. Think of the snowball effect. The rapid growth in passive funds leads to the inevitable bias in market valuations, favouring index-linked stocks at the expense of non-index-linked ones.
We have previously explained how stocks with very high liquidity tend to trade at significant premium valuations (refer to our article “The value of liquidity” in Issue 1374, June 14). It also means that, although markets are generally efficient, there can be short-term mispricing for lower-profile, smaller companies — and stock pickers capitalise on this, by finding these fundamentally undervalued stocks, and earn above-market-average returns.
Indeed, this is what we did for the Malaysian Portfolio, because we have home ground advantage — the necessary indepth knowledge of the market and idiosyncrasies of individual Malaysian companies. Historically, almost all of the stocks from which we made big returns have been smaller and mid-sized cap stocks that are under-researched and thus, undervalued. And we bet investors with knowledge of the US market will similarly be able to make higher-than-market-average returns through active stock picking.
In short, a global portfolio of equities makes good money sense — opportunities are global and not limited to national boundaries. You can beat the market with active stock picking if you possess the necessary knowledge. Unfortunately, the average investor is not Warren Buffett. In which case, most would be better off buying passive mutual funds and ETFs, which have very low costs and are liquid and easy to trade. Your focus should be on making the call on markets, based on comparative macroeconomic indicators and valuations. The importance of individual stocks takes a backseat — because a rising tide will lift all boats.
The Global Portfolio gained 2.8% for the week ended Aug 25. Some of the biggest gainers were ServiceNow (+6.7%), Builders FirstSource (+6.4%) and Taiwan Semiconductor Manufacturing Co (6%). Meanwhile, only three stocks closed in the red last week: Alibaba Group Holding (-4.4%), General Motors (-2.2%) and Johnson & Johnson (-1.7%). Total Global Portfolio returns since inception now stand at 63.4%. This portfolio is outperforming the benchmark MSCI World Net Return Index, which is up 58.5% over the same period.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.