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INVESTMENT STRATEGIES GEOGRAPHICAL ALLOCATION

“ We do not get involved in geographical allocation in equity markets because we have no evidence we are any good at it, and we have scant evidence that virtually anybody else is any good at it ”

Dan Kemp, investment director, Saltus

Correlation table – 1 year to 4 Dec ’09

FTSE 100 FTSE World Europe MSCI EM S&P 500 Topix FTSE 100 Benchmark 0.98 0.83 0.85 0.89 FTSE World Europe 0.98 Benchmark 0.88 0.92 0.89 MSCI EM 0.83 0.88 Benchmark 0.83 0.7 S&P 500 0.85 0.92 0.83 Benchmark 0.82 Topix 0.89 0.89 0.7 0.82 Benchmark

Source: Morningstar Correlation table – 3 years to 4 Dec ’09

FTSE 100 FTSE World Europe MSCI EM S&P 500 Topix FTSE 100 Benchmark 0.94 0.87 0.83 0.7 FTSE World Europe 0.87 Benchmark 0.89 0.89 0.78 MSCI EM 0.83 0.89 Benchmark 0.73 0.65 S&P 500 0.7 0.78 0.65 Benchmark 0.73 Topix Source: Morningstar 0.7 0.78 0.65 0.73 Benchmark

Correlation table – 10 years to 4 Dec ’09

FTSE 100 FTSE World Europe MSCI EM S&P 500 Topix FTSE 100 Benchmark 0.94 0.78 0.84 0.53 FTSE World Europe 0.94 Benchmark 0.82 0.86 0.55 MSCI EM 0.78 0.82 Benchmark 0.75 0.59 S&P 500 0.84 0.86 0.75 Benchmark 0.58 Topix Source: Morningstar

0.53 0.55 0.59 0.58 Benchmark

“In many funds, managers are allowed to have, say, 20% outside of their main area, and I have seen UK special situations funds that have direct exposure to Chinese stocks.” He adds: “I think it is wrong to put managers into boxes because the reality is while most of them have currently got dollar earners, as that is probably the right place to be, if they thought it was appropriate they would switch to domestic earners. It can be too simplistic if you just look at the headline, you can miss what is going on underneath the surface.” Sure, geographical segregation serves to give investors a practical handle on the nature of their equity exposure, risk and even

clues to its liquidity, but would it not be more useful to look first on a thematic basis, or through sector allocation?

l Thematic investing

Peter Hicks, head of UK retail sales at Fidelity International, points out that while multi-managers, discretionaries and wealth advisers do not traditionally invest in global growth funds per se, they will still invest in far-reaching global funds through thematic products. He says: “More people invest in global funds than you might think, but the first decision is a thematic one, such as focus on consumer areas, real assets or healthcare.”

Dan Kemp, investment director at Saltus, also follows a thematic approach to an extent by investing solely through asset class. If he wants generic equity exposure, he will invest roughly in line with a global benchmark, such as the MSCI World, and within that hedge currencies or have higher or lower beta exposure where appropriate. He says: “We do not get involved in geographical allocation in equity markets because we have no evidence we are any good at it, and we have scant evidence that virtually anybody else is any good at it. Our approach is to ask which assets at the moment have the best return/risk profile, that is, what do

we think offers the best value for the level of risk, whether that is potential downside or volatility?”

l Globalised markets

Kemp’s own research shows that by comparing the performance of the MSCI Emerging Markets index since it was formed in 1995 with the MSCI World, there is an almost perfect correlation of returns; except there is much higher beta in emerging markets (see graph on page 22). He adds: “If you thought equities were going up over the past 15 years, you would buy emerging markets because they go up faster. If you thought the market was to go down, then you do not hold emerging markets because they go down faster and the developed markets go down slower – you can accomplish that without any geographical allocation, just a balance of the S&P 500 and cash.” Of course, as Kemp himself acknowledges, there will be times when geographical allocation does take on more importance and can make a big impact on returns. For example, fund managers would have benefited greatly from avoiding Japan throughout the 1990s. However, asset allocators point out that as equity markets have become more globalised, the difference in behaviour of the major stock market indices has lessened. A UK-based investor might be wise to assume that if the S&P 500 rises in the afternoon, there is a very strong chance that Asian indices will rise overnight and that the FTSE 100 will rise tomorrow, providing of course there has been no great global shocks to financial markets

18 PORTFOLIO ADVISER [www.portfolio-adviser.com] JANUARY 2010

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