Ignore global assets at your peril

Over-emphasising Australian assets in a portfolio at the expense of global stocks also heightens risk.

“One thing all economists agree on is diversification is a free lunch. By going global, you get a fair amount of diversification,” says Bhanu Singh, chief executive at fund manager Dimensional Fund Advisors.

“There’s too much risk in your portfolio if you’re just invested in the four banks and BHP,” he says.

Even if 50 per cent of the portfolio is in Australian assets and 50 per cent is in global markets, Singh says investors underestimate their concentration risk. This is the risk of investing in a relatively small number of assets versus a more diversified portfolio.

As a layer of diversification, he says most of Dimensional’s portfolios are tilted towards mid-cap and small-cap stocks, which reduces the concentration in big name shares.

To hedge or not to hedge

It’s worth noting the Australian share market does have some advantages over other markets, such as access to franking credits and the dividend imputation scheme.

There are also downsides to investing overseas, such as higher costs and currency risk, although Singh downplays this. “If you look at a hedged portfolio versus an unhedged portfolio, returns are roughly the same in the long run and volatility is the same,” he says.

Also, although global markets did well this year, that’s no guarantee of a repeat performance next year.

In terms of the outlook for global markets for 2024, inflation is expected to continue to ease in the US as the US Federal Reserve’s program of interest rate rises slow the economy. But there are still opportunities if investors know where to look.

“We expect structural changes like artificial intelligence to accelerate, despite these macroeconomic factors,” says Kieran Moore, partner and portfolio manager, Munro Partners.

Moore believes many businesses that are growing their earnings, backed by a structural change, are mispriced or underappreciated by the market. He says the investment backdrop should be positive in 2024 for companies with a structural tailwind behind their earnings growth.

“Should the broader economy continue to slow, we expect investors to gravitate towards companies with strong earnings growth, driven by changes such as the acceleration in AI. Investing globally offers investors a broader exposure to sectors with limited exposure in the Australian market,” says Moore.

Hugh Selby-Smith, co-chief investment officer at global investment experts Talaria Capital, agrees that after a strong year so far, the outlook for global equities is challenging, but contains opportunities.

“The lagged impact of monetary policy means it’s typically 18 to 24 months before crucial parts of the economy such as unemployment rates and commercial and industrial loans are affected. We have just entered this phase, after a period of the fastest and tightest interest rate rises since the great inflation of the 1970s,” he says.

Avoid the crowds

Against this backdrop, Selby-Smith says equities investors should avoid leverage and own more efficient, cheaper and less crowded stocks.

“With US stocks making up around 70 per cent of the global index, other regions currently offer more opportunities,” says Selby-Smith.

Talaria favours an active investment strategy in the current environment. This is because there is a significant concentration risk in many passive portfolios, with the US making up such a large proportion of global indices and a small handful of giants dominating the US bourse.

“Active managers are better placed to navigate this backdrop as they can have lower beta and can avoid leverage and crowded stocks,” Selby-Smith says. Beta is a way of measuring volatility.

Investing in global markets is now much easier for retail investors than it was in the past. Many online trading platforms offer international investing and stockbrokers can facilitate international trades, too.

In addition, there is a plethora of exchange-traded funds and managed funds, both passive and active, that allow investors to tap into a range of foreign markets, or a subset via a specific sector index.

The idea is to form a thesis of the future and find stocks or funds to match it, keeping a watching brief on the outlook and being mindful of long-term investment goals.