Global Investing in a Changing World - Angles & Perspectives Q3 2023

Global investing in a changing world

Perspective is often only gained in hindsight. While many investors may not fully appreciate it, we have experienced an extraordinary period since the end of the Global Financial Crisis (GFC), marked by low inflation, low interest rates and stagnant growth. However, we believe it is probable that financial markets have been undergoing a structural inflection since 2020 and the onset of the Covid-19 pandemic, with the next decade likely to be very different to that which preceded it. However, we are concerned that, when analysing market and major investor positioning, we see a ‘business as usual’ approach that looks ill-equipped to weather a changing of the guard.

Recent US outperformance has been exceptional

The level of US outperformance, when compared to the rest of the global equity market since the GFC, has been extraordinary. For more than a decade, the recipe for success was simple: ‘getting it right’ meant selecting the US market, and technology stocks specifically.

The immense outperformance of technology shares, in addition to exceptional business performance, was driven by an ‘easy money’, low interest rate environment that favoured long duration stocks. Furthermore, the US saw a quick recovery from the Covid-19 pandemic that boosted its economic performance. Tech-heavy US indices benefited disproportionately.

As the consensus about the recipe for success has become more entrenched, so too has manager positioning. Our investment style analysis of 350 of the largest selected global equity funds shows that most market participants have portfolios centred on positioning in large and giant market caps and close to the index, in general.

The positioning of passive indices also attests to this growing concentration: the share of the United States in the MSCI World Index is back to historically high levels. Interestingly, within the MSCI USA Index, information technology and communication services account for 37% of the index while energy and materials are less than 7%.

But what if the future is set to look very different to the past?

The concept of recency bias in behavioural finance suggests that investors tend to overweight the relevance of recent experiences, more than is objectively warranted. We believe sound, independent research and an appreciation of historical context help to counter this innate bias.

• Long-term investors in our funds will know that we are a bottom-up research-driven house, meaning that our independent research into companies and fixed income instruments drives our portfolio decisions. However, we believe it is complementary to be macro aware. Our research into the macro environment suggests that we have reached an inflection point. This is driven by the unwinding of imbalances that have been building since the GFC, due to an artificially low interest rate environment. The likely end of the disinflationary environment and a four-decade bull market in bonds, coupled with significant under-investment in the real economy over the past decade, an energy transition and the need to build supply chain redundancy given the volatile and uncertain geopolitical environment, suggests the future is likely to look very different to the post-GFC period. Read more about our thinking on this topic, and the impact we believe it to have on various asset classes, in our previous editions of Angles & Perspectives (Second Quarter 2022, Fourth Quarter 2022).

• In addition, we believe an appreciation of the importance of longer-term perspectives when making decisions is invaluable. To this end, we have analysed historical cycles and we have found that ‘the popular consensus’ view about the assets that are likely to outperform, often turns out incorrect in hindsight. See our case study below.

Where do the opportunities reside?

If the past is likely to be a poor predictor of future success, and if history has shown that the top performers can reverse sharply from one decade to the next, how are investors best to approach this environment, and where are the opportunities likely to be found?

Interestingly, some of the likely net beneficiaries of a changing environment – stocks outside the US – are trading at the largest valuation discount seen in decades. Many of these likely beneficiaries are also underrepresented in major indices and many popular index-hugging investment portfolios. Another important feature of today’s market structure is the valuation gap between large and smaller cap companies, which is among the widest we have seen in decades.

We believe that, rather than positioning their portfolios for the current popular narrative that sees a continued outperformance in US and technology stocks, investors need to look ahead and position their portfolios to be exposed to the beneficiaries of the changing environment. This becomes even more relevant given the significant concentration in the market in the last decade’s winners. Independent thinking is more important than ever.

By consistently applying our 3M investment process and seeking out under-appreciated quality that trades at depressed valuations in uncrowded areas, we have constructed portfolios that attempt to avoid falling prey to the temptation of clustering into what is currently popular. We believe we are well placed to uncover hidden gems that help tilt the odds of long-term success in our investors’ favour. Those already familiar with our thinking would not be surprised that we are currently finding opportunities in international equities largely outside the US and in real asset sectors, such as energy and materials.