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Diversification is the only ‘free lunch’ in the current market

By Rhea Nath
6 minute read

With none of the regions outside the US trading at more expensive levels than their historic averages, an investment specialist has outlined the compelling opportunity to fight home bias in portfolios.

While much of the market buzz has surrounded the Magnificent 7 stocks in the US, JP Morgan Asset Management (JPMAM) believes there is a case to be made for other opportunities, including in the S&P 493 and Europe.

Speaking at the Stockbrokers and Investment Advisers Association (SIAA) 2024 Conference in Melbourne, Regina Liu, managing director at JPMAM, observed there has been an “extreme and narrow” market rally around tech stocks, leading to discussions around whether US equities have simply become too expensive.

However, for capital appreciation over the long term, she asserted developed market equities are “still one of the asset classes you cannot do without in your investment portfolio”.

“If you break down the entire global equity markets by regions, I would still argue that apart from the US, which is the big elephant in the room, none of the regions are trading at much more expensive levels than their historic averages,” Liu told audience members.

“Even if you look at the US, if you take out the seven mega tech stocks and look at the S&P 493, the valuations are not that stretched. If you really have to address the big question in terms of where these tech stocks are going in terms of valuations, they’re not as stretched as they were in 2021.”

For the investment executive, the data is not “uncompelling” from a valuations standpoint. However, to make the most of these opportunities, investors will have to shrug off a bias towards domestic and more familiar stocks.

“A lot of names in the US are household names, like Amazon and Microsoft, names you know and are familiar with.

“Names in Europe tend to be a lot more focused on business-to-business type of opportunities, so there will be companies you’re less familiar with which are also participating in the tech space, such as the likes of Infinian and ASML. They might be less familiar, but it doesn’t mean it doesn’t represent good investment opportunities just because the US has been dominating a lot of the headline news,” she said.

Last year, the 2023 ASX Australian Investor Study found Australian shares are still the most popular of all on-exchange investments in the country, with around 58 per cent of Australian investors owning domestic shares directly compared to 16 per cent of direct holdings in international shares.

Weighing in on this trend, Liu said it’s not unique to Australia.

“We do see that across the board. A lot of times, when I do cover the market, you see Japan investors tend to just invest in Japanese companies, Korean clients tend to do the same,” she shared.

However, franking credits remains one of the features that has been unique to the Australian market. According to Liu, they make investors “feel more comfortable” as they’re seeing the savings from a tax perspective immediately.

“At the end of the day, we do see reasons to diversify outside your home market.

“For Australia, for example, if you look at the MSCI World index, Australia makes up about 2 per cent of the index, so it is probably true that when you’re looking at a market of the MSCI World, which consists of around 1,600 companies, there are a lot of investment opportunities you could have missed if you’re only focusing on companies you do know.”

She added that some of the highest quality names in the home market tend to be overvalued or expensive, given that a lot of the large institutional clients and retail clients alike are trying to hold the same high-quality names within a relatively smaller market.

“I feel the need to have this conversation with any investor with a home bias, that diversification is worth a little bit of attention and at least a little bit of investigation or exploration,” she said.

Investors shouldn’t discount Europe

Last month, the global asset manager brought its 10th offering to the Australian active equity ETF space with the launch of its high conviction Global Select Equity Active ETF (JGLO) on the ASX.

It follows the same strategy as its existing JPMorgan Global Select Equity Strategy, which is a core, style-agnostic, high conviction diversified global equity portfolio that aims to deliver outperformance across a variety of market conditions.

Outlining the firm’s active management approach, she said JPMAM continues to advocate for diversification in its equity investments.

“In this market environment, we do continue to feel diversification is probably still the only free lunch you can get,” Liu said.

“Not all opportunities are built equal, so at the end of the day, being able to leverage some of the active management and selection, leveraging good research analysis is going to be differentiating when it comes to a global equity investment.”

Unpacking this diversification, she said JPMAM remains “agnostic” regarding the location where a company is listed. Rather, it is interested in the company’s revenue generation exposure, as well as the source of the company’s growth.

“In terms of company listing in JGLO, about 70 per cent of the portfolio is listed in the US, but from a revenue generation perspective, we only consider about 50 per cent of the portfolio has a US exposure,” she explained.

“Similarly, we have an emerging market (EM) exposure from a company listing perspective of about 4–5 per cent, but we actually see that the portfolio overall has no less than 15 per cent of the portfolio having EM exposure.

“Increasingly, we’re finding ourselves trying to gain that market exposure via those global multinational companies.”

In the case of French-listed company LVMH, which includes a number of luxury brands like Louis Vuitton, Kenzo, Marc Jacobs, Tiffany & Co, and Dior, the majority (over 60 per cent) of its revenue comes from outside Europe, she observed.

However, this has been a region that has seen investor hesitance, given lower growth, war, and potential rate cuts.

“What I would say to that is, investing in European companies should be decoupled with investing in Europe as a market,” Liu argued.

“If you look at the MSCI Europe as an index, 50 per cent of the revenue of companies on MSCI Europe are not really operating in Europe, they’re actually getting a lot of their exposure outside.”

According to Liu, while Europe has seen about US$500 billion of net outflows since 2008, the tides look to be turning for this market.

“Europe has done poorly economically […] especially when back in 2008, about a third of the index is banks, and with the ultra-low interest rate environment, it was very difficult for a third of the index to perform,” she said.

However, banks look to make a resurgence as interest rates normalise.

“We’re seeing banks come back very significantly, with return on equity from about 2–3 per cent on average in the last 15 years now to about 12 per cent or so. We are seeing the market looking very attractive, in the sense that it is generating revenue outside of Europe, but it is actually still trading at very cheap valuations relative to the rest of the world.”