Friday, 28 April 2017

Globalisation (Part Two) – Regional Weightings and Fund Management

As a continuation to the previous article on globalization, this focuses on the importance of geographical fund weightings in portfolio management.  In the modern investment market climate, some investors may argue that the sweeping globalisation of companies has made the importance of the geographical make up of funds less relevant and that markets have become more correlated.
Given that transport and communication links between countries and regions have improved exponentially over the years, the proportions of global-facing companies within various indices has gradually increased. In 2016 saw the Sterling fall to a six year low against the Euro after the Brexit referendum, but this decline actually bolstered the performance of the FTSE 100 index, given its dependence on exports to overseas countries where their currencies were comparatively stronger.
Examples like this naturally lead investors to wonder if they should pay less attention to the regional weightings of the funds they are buying into and instead focus more on other micro fundamentals.  But it is important to remember that, certainly in the case of investing via ‘actively managed’ funds, the part of the active fund management you are paying for is in BOTH geographical AND regional allocations – and it is the details of both area that can really make a difference to your portfolio’s performance. 
Information provided on a fund factsheet enables an investor to understand where a fund manager is underweight or overweight relative to the index, and offers an  insight into the fund’s strategy.  It will allow you to know (to a certain extent) where the exposure of their fund lies.  If a fund invests in mid and small-cap companies then it is important, as these will be more domestically-focused, however, if the funds is more focused on large-cap stocks, then the country they are based in is of less relevance.
It is arguably the fund’s stock selection rather than country selection that is most important in terms of day to day results, but knowing how much a fund has allocated to each country can help with overall portfolio construction.  It can also help to determine the risk of the fund.  For example a higher weighting in emerging markets would suggest higher risk whilst a very high singular country weighting could indicate the fund manager is just trading on the momentum of a country over genuine stock selection and analysis.
If you hold a portfolio of global funds then you are simply relying on the fund manager to pick the best stocks, sectors and countries.  However If you use the popular ‘core and satellite’ approach to your portfolio – in other words, holding global funds as a core and then selecting individual country funds alongside - it is important to know the asset allocation of the global funds to ensure you aren't doubling up on positions without realizing.
To make things even more complex, often investors will confuse geographical market allocations with exposure to a particular economy, but in many cases the relationship is pretty marginal or even irrelevant.  I recently read an article containing a perfect example of this, concerning an investment with Anheuser-Busch In-Bev.  A portfolio with a large position with this company might on the surface look like a big punt on Belgium, but in reality the world’s biggest brewer has more exposure to Mexico than France’s small neighbour.  Likewise, Switzerland represents a big slice of European markets because it is the domicile for global giants such as Nestle and Novartis rather than because of its domestic economy.

What investors need to realise, is that to a large extent information being provided on fund factsheets is yet to catch up with the true effects of globalization.  The geographic weighting allocation given by fund managers needs to be based on where individual underlying earnings exposure are, so a more meaningful picture of how sensitive a fund or portfolio is to a particular economy or region can be established.  Both micro and macro events have huge parts to play in how stock markets, and ultimately, our own investments perform.  It is only by understanding both factors that investors can choose the funds and investment strategies that best suit their individual needs.

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