"Traditional strategies in need of rethink"
by Gary Motyl
Financial Times
7 June 2004
Many globetrotting investors have long approached their portfolios like a multilane highway. With local and regional economies often going at separate speeds, they set up parallel portfolios usually run by different managers - some focusing on US stocks and others on European, Asian, or emerging markets.
After all, the conventional wisdom went, diversification is a cardinal rule of investing, and entirely different types of investment expertise are needed to invest in US and non-US equities.
But the global economy is rapidly changing, and this traditional approach is facing fundamental challenges. As the US economy pulls out of its recent malaise, many economies around the world are following.
It is becoming increasingly clear that regardless of location, companies are exposed to global influences-whether through their customers, suppliers or competitors. They are far less dependent on cultural or trade borders. Among the world's top semiconductor companies, for example, one may be in the US and another in Taiwan or Japan. Leadership can shift rapidly in many industries, including autos, software, pharmaceuticals, manufacturing and materials.
It makes sense under these circumstances to take a different approach to investing-a global approach. The larger the opportunity set, the better the chances for finding good investments. A global approach broadens investors' choices and increases their flexibility, allowing them to ride valuation waves between emerging and developed countries, between capitalisation ranges, and between companies in similar sectors around the globe.
Many trends point to the value of a global approach. The most important is the increasing integration of the global economy. Global trade agreements such as Nafta are reducing trade barriers. Transportation is becoming cheaper and faster. Information flow is greater, and accounting standards are being harmonised. There has also been a strong increase in global outsourcing, and an increased reliance on foreign suppliers for raw materials. The establishment of a single currency in Europe and a unified monetary policy has lead to more synchronised performance across European markets.
Globalisation is changing not only Europe, but many developed markets around the globe. This is borne out in part by a striking increase in the similarity of movements-analysts call this a "high correlation"-of US and non-US stock markets. This trend has been most notable among large-cap stocks.
An argument can be made that if global markets are increasingly moving in tandem, there is no reason to diversify outside of the US or Europe. But this misses the importance of globalisation. Increasingly, the best companies in many industries can be found anywhere around the world, and investors need to be flexible enough to go wherever the best investments can be found. While local economic and political issues are always important, sector factors have become even more significant.
In the pharmaceutical industry, the US is the market of choice for companies because pricing is significantly less regulated. But the US is also heavily exposed to generic competition, which has been increasing from companies in Israel, India, and eastern Europe.
The strength of many non-US companies is reinforced by the growth of global markets. According to IBES estimates and Factset, as of April 25 2004 there were about 5,050 companies around the world capitalised at $1bn or more, of which two-thirds were based outside the US. Among these companies, there were 977 with earnings growth forecast at more than 15 per cent. The US had only 451.
Several emerging markets countries, such as South Korea, are expected to move to developed status in the near future. While companies in emerging markets tend to be smaller, many are promising growth companies.
Many large investment firms are reshaping their research units to focus on global sectors. Instead of having sector analysts focus on specific geographic regions, research is being organised around global economic or industrial sectors, with a regional overlay.
Currencies are an integral part of analysing investment opportunities, and in the short term they can be volatile and difficult to forecast. But currency movements reflect some degree of purchasing power parity and, over the long term, currency movements can provide a form of portfolio diversification, along with country and industry diversification.
In non-US markets there is a change under way in the focus of many corporate managements. There is now a greater acceptance of the concept of enhancing shareholder value. Companies are moving independently to adopt US-style corporate governance standards, and governments are enhancing regulatory frameworks with a view to attracting and retaining foreign investors. An increasing number of these companies now use GAAP accounting.
All these trends point to the need for new thinking by investors. It is time to adopt a global approach, to conduct research structured along global industry and sector lines, and invest wherever and whenever valuations are most favourable.
The author is chief investment officer of Templeton Institutional Global Equities
This article appeared in the Global Investing section of the Financial Times newspaper on 7 June 2004. For more information, please visit the Financial Times website at FT.com.
This article has been reprinted with the permission of the Financial Times. The Financial Times is not affiliated with Franklin Templeton Investments.
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