While this appears to be a fairly straightforward question, it is one that can be attacked from various angles. As a general case, Seed would typically have at least a small allocation to both, because the diversification benefits obtained by investing across geographies greatly enhances an investor’s expected risk adjusted returns. What we continuously grapple with is the relative weighting to each of these geographies (bearing in mind that ‘global’ in itself is made up of a multitude of regions) when considering an investor’s specific requirements.
Let’s start with the local market. Over the course of the past few years we have often written about the composition of the local market and how it is no longer just exposed to the local economy (it now has greater exposure to foreign economies). It has changed dramatically over the years. Everyone knows that South Africa relies less on resources now than it did in the past, but the chart below taken from BCA’s latest Quarterly Report was quite eye opening.
In the space of 7 short years the composition of the local market (using the MSCI index – which is comprised of only those companies with a primary listing in South Africa, i.e. excluding British American Tobacco, SABMiller, Glencore, Richemont, BHPBilliton, Anglo American, etc) has changed from being dominated by materials (primarily resource companies) to one that is dominated by consumer discretionary companies (Naspers, Steinhoff, etc).
When looking at the composition of the more commonly referenced ALSI in the chart below – a similar trend can be seen. As a result, a lot of historical analysis on the local ‘market’ has to be discounted to a certain extent.
A conclusion from these charts is that the South African market is no longer a good proxy for South African company earnings. Also, the broad composition of any index can and does often change quite dramatically over time. While resources were once of major importance for any local investor, they are now less important than consumer services, financials, and consumer goods! Equally, indices around the world are often not representative of the country’s underlying economy. Investors should therefore be wary of blindly investing into ‘market’ indices.
Another important determinant of where one should invest is valuations. In this regard BCA also look at various valuation measures. The chart below shows how global markets are currently approaching expensive territory while local markets, despite the recent correction, are also still very expensive when applying Seed’s various valuation measures.
Again, the definition of ‘global equity’ is very broad and will incorporate regions that are more expensive and cheaper than the average shown above. With global equities closer to being ‘expensive’ than ‘fair’ or ‘inexpensive’ it is fair enough to ask why our Funds are typically overweight global equity. The short answer (backed up by other, independent, research) is that most other assets are also expensive, and that equities at least offer the patient investor an opportunity to participate in a growing income stream.
Markets have evolved to such an extent that investors can no longer just ‘look at the box’ when making investments. At the bear minimum they need to ‘look inside the box’ to ensure that they are, in fact, exposing themselves to their desired risk drivers. Professional managers allocate significant human resources to fully understand these dynamics, and then construct portfolios that blend and diversify the various risks on offer to generate superior risk adjusted returns.