U.S. investors, like their peers abroad, have a tendency to exhibit a material home country bias in their asset allocations. Further, when they do invest overseas, they typically do so through dedicated international funds. Consider the following category asset levels reported by Morningstar, as of
December 31, 2015:
U.S. Investors Exhibit a Home Country Bias
This suggests that on average, U.S. mutual fund investors have about an 80/20 split between U.S. and international developed stocks, despite the fact that the global developed equity market, as defined by the MSCI World Index, is weighted roughly 58% to U.S. equities and 42% to international equities. In addition, a mere 6% of all assets in global developed markets are invested through World Stock funds.
“We believe that due to the evolution of global markets and the ever-changing opportunity set facing equity investors, they should consider evolving as well—moving away from an approach that utilizes regional mandates, and instead opt for a global approach.”
› Evolving Markets
Global markets have become considerably more integrated over the last two decades. As a result, industry factors now dominate country factors in terms of explaining stock market returns.1,2 Additionally, most mid to large cap companies now generate substantial revenue abroad. In fact, overseas revenues to S&P 500 companies exceeded 46% in 2013.3 Where a company domiciles is becoming less relevant.
› Improved Opportunity Sets
An analyst covering semiconductors, for example, needs to understand and have a view, not only on U.S. based firms like Intel, Micron Technology and AMD, but also the deals for Samsung s8 and SK Hynix in South Korea, STMicroelectronics in France, Toshiba and Sony in Japan, Infineaon Technologies in Germany and MediaTek in Taiwan. If that analyst is going to do the hard work to form views on those geographically diverse firms, why artificially constrain the buy decision to U.S. firms? European firms? Asian firms? Doing so introduces information leakage into the investment process.
⋅ Style factors, like value, momentum, quality, etc. are explanatory across markets, and managers who focus on factor exposures shouldn’t be constrained to express their views in a single market, or the result could be sub-optimal.
⋅ Behavioral biases, like style factors, are universal. Managers who target the inefficiencies created by investor biases benefit from the flexibility to invest across markets.
› Better Risk Management
Most investors tend to allocate to regional specialist, and as a result, exhibit major home country biases, which is less-than-optimal from a risk management perspective. By allocating to global managers, investors benefit from greater diversification, and put the onus on professionals to manage regional exposures according to the ever-changing opportunity set and accompanying risks. Further, allocating to global managers can reduce the number of managers in a portfolio, which makes it easier to understand the aggregated risk exposures, intended or otherwise, that are present in a portfolio.
› Simplified Asset Allocation & Portfolio Construction Processes
The more granular the mandates (think “U.S. mid cap value” as opposed to “U.S. equity”) the more granular the capital market assumptions need to be, which adds complexity and increases the sources of error. Further, as investors have come to understand and include an increasing number of asset classes and strategies when constructing portfolios, the number of managers utilized has ballooned. When investors mainly allocated to U.S. equities, international equities and investment grade bonds, portfolios were quite simple. But now, it’s
common for even retail investors to have exposure to TIPS, emerging market equities and debt, real estate, and a host of liquid alternatives, for example. While we believe in broadly
diversifying across asset classes, geographies and strategy types, doing so results in significantly more complex portfolios, which as mentioned previously, comes with risk measurement and management issues.
› Reduced Costs
Due diligence, properly done, is a resource-intensive process, so if you are going to do the work to identify skilled managers, why artificially constrain them once identified? By making larger allocations to fewer high-conviction, geographically unconstrained managers, both the initial search costs and the ongoing monitoring costs are lessened. Additionally, allocating more money to fewer managers allows for the possibility of reduced management costs,
whether that be related to the ability to access institutional share classes of mutual funds, or due to declining fee schedules for separately managed accounts.
1 Cavaglia, Stefano, Christopher Brightman and Michael Aked. “The Increasing Importance of Industry Factors.” Financial Analyst Journal, vol. 56, no. 5 (September/October 2000):41-54
2 Kang, Xiaowei and Nielsen, Frank and Fachinotti, Giacomo. The ‘New Classic’ Equity Allocation (October 1, 2010). MSCI Barra Research Paper No. 2010-33. Available at SSRN: http://ssrn.com/abstract=1708269
3 Silverblatt, Howard. “S&P 500 2013: Global Sales Year in Review” (August 2014). S&P Dow Jones Indices Research Paper. Available at: https://us.spindices. com/documents/research/research-sp500-2013-global-sales.pdf?force_download=true
The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Please note that changes in the rate of exchange of a currency may affect the value, price or income of an investment adversely.
The opinions are those of the 361 Capital Investment Team, as of December 2015 and are subject to change at any time due to changes in market or economic conditions. The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes. 361 Capital makes no representation as to whether any illustration/example mentioned in this document is now or was ever held in any products advised by 361 Capital. Past performance is not indicative of future results. Illustrations are only for the limited purpose of analyzing general market or economic conditions and demonstrating 361 Capital’s research process. In preparing this document, 361 Capital has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources.
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