When investing in global equities, super funds need to look for global diversification and avoid additional indirect exposure to China.
Domestic portfolios of Australian investors are heavily exposed to the Chinese economy through the mining sector. Taking a closer look at the composition of the S&P ASX 200 index, basic materials currently account for 20 per cent, oil and gas for 6 per cent, financials for around 42 per cent and industrials for 8 per cent. In other words, the index by definition has more than 75 per cent exposure to cyclical stocks and at least 25 per cent exposure to stocks directly driven by Chinese demand.
Considering that the typical balanced option of a superfund may have one third in domestic equities, funds already have a high level of cyclical exposure and indirect exposure to China embedded in them. As such, we believe an important goal for super funds investing in international equities should be to find less cyclical companies, offering growth opportunities that are not linked to the same set of earnings risks.
Focusing on earnings diversification, rather than sector diversification, is important in our view, because owning high-quality companies in the same broad sector, but with different earnings drivers – for example in distinct consumer markets – may be a better choice than owning companies in different sectors that are closely correlated to the same earnings driver. For example, mining, steel, luxury cars and China growth.
Growth has continued to slow in China
In China, while the central bank has cut interest rates in an effort to moderate the country’s economic slowdown, some tightening measures remain in place. China’s policy response may not be fully realised until its new leadership takes over and is bedded down. At Vontobel, we expect domestic consumption of smaller-ticket items to remain robust and we have concentrated our Chinese equity exposure in companies operating in the food, beverages, mobile phones, internet search and gaming segments. We are much less convinced that spending on larger Chinese fixed-asset investments in real estate or in areas such as high-speed trains, toll roads and airports, will continue at the same pace over the next decade as it has in the last.
Identifying opportunities globally
Looking beyond China, and taking a truly global view, allows investors to consider investing in multinationals, many of which offer diverse exposure to a large number of different market segments, helping to diversify earnings risk. Such examples include consumer-orientated businesses like Nestle, which has a strong footprint in both developed and developing markets; BAT, which operates in more than 50 countries; and financials such as HSBC, which benefits from a particularly strong position in Hong Kong and emerging Asian markets, and Citigroup, which has enjoyed considerable success in Latin America.
It’s the company, not the market
Many investors are asking whether recent market weakness makes this a good time to invest in China. We do not approach investing this way. As bottom-up, global investors, we believe in owning the right companies, irrespective of their domicile. This means looking for well-priced companies with strong franchises that offer favourable and relatively certain long-term growth prospects.
The importance of selecting the right companies is well illustrated by recent events in the Chinese property market. Over-levered property developers in China have been selling assets under pressure, giving better managed companies an opportunity to buy those assets at depressed prices and to position themselves for the future.
As China’s slowdown continues, we think a company-specific, rather than a market-specific investment approach is more likely to pay off for investors. We will continue to focus our investment approach on finding companies with strong, predictable earnings growth potential, as we hunt the globe for what we believe are truly ‘long-tail’ businesses.
Jürg Fritschi is the Asia-Pacific executive director of Vontobel Asset Management
