As the importance of sovereign boundaries diminishes, the investing focus shifts toward sector analysis and best-in-class opportunities.
If institutional investors had any doubts about how connected the world’s economies have become, the recent financial crisis and subsequent global stock market decline eliminated any question about the veracity of such claims. Long-held principles of asset class correlation and diversification by geography — the foundations of many asset allocation models — tend to break down when economies falter, as demonstrated during the latest financial crisis.
In light of recent market events, Northern Trust convened a panel of its global investing experts to discuss how a different approach to the world’s capital markets may help investors outperform their benchmarks. The roundtable featured John Cole, head of global active equities; George Maris, senior portfolio manager, U.S. core and global equities; Scott Ayres, senior product manager, active equity; and Mark Sodergren, senior portfolio manager, Quantitative Management Group.
John Cole: Historically, global investing has been about diversification. We believe that in leveraging a broad array of research from around the world and understanding risk, we do not have to rely on passive global diversification. Instead, we can diversify globally by selecting best-in-class opportunities among individual stocks and sectors, regardless of geographic boundaries, potentially providing excess return in addition to diversification.
George Maris: Global equity investing has undergone significant change over the past fifteen years, where the influence of country and region has waned, while sector and security selection have gained importance. This trend has been fairly consistent and very pronounced, creating greater correlation. In our view, global equity investing requires looking at sectors across both broadly developed markets and some emerging markets. Using a sector-based approach to identifying the best companies, an investor might add alpha and diversification through the stock selection process.
John Cole: No. However, correlations become especially magnified during times of financial stress. But, we are also mindful of the fact that there are still differences between regions, even as correlations grow closer. Knowing this, we refresh our risk profiles and screenings weekly, focus on key fundamental factors, such as earnings quality, valuations, trends, capital deployment and market behavior, then make judgments as a team about potential changes, risks and opportunities.
Scott Ayres: Look at Korea and Taiwan. They have some very large global companies. From a correlation perspective, the biggest companies behave more like those in developed economies, not emerging markets. Samsung, LG and Taiwan Semiconductor are very large companies whose reach extends well beyond their borders. We tend to focus on emerging markets that have these types of companies.
John Cole: Some sectors have relatively uniform global characteristics. Energy, commodities, materials and pharmaceuticals are examples of sectors that generally are driven by macroeconomic global factors. Other sectors, including financials, have global influences and local characteristics that tend to differ by country and region. For example, a large, global financial institution is affected by the global financial crisis, but other financials that focus primarily on domestic business may be less affected. In contrast, the consumer discretionary and utilities sectors generally have more local than global influence.
Mark Sodergren: I would agree with John and add that there are exceptions within each broad classification. The consumer discretionary sector may be local in general, but is global for sub-industries in the sector, such as automakers. Industrials are both global and local. Within healthcare, the pharmaceutical and bioscience industries contain companies that are global, but healthcare insurers are local and the medical device sub-industry is mixed. When we analyze companies, we acknowledge the variances within each industry and country. Then we look at not only the environment for industries today, but also where they may head tomorrow.
George Maris: One only needs to look at the changes wrought by improved technology and logistics to see that even in the most local industries, companies are more dependent on one another. We have to view everything in a much more global manner.
Take Boeing, for example. A worker’s strike contributed to the delay of the delivery of its 787 Dreamliner. Alcoa and Vought Aircraft Industries were among the many companies that sell materials or make parts for Boeing and saw their business decline. The strike’s effects spread to France’s Safran, which makes engines for the 787, and delayed planned growth for Air Canada, Virgin and Ryanair.
Scott Ayres: By looking globally, we have opened our investing horizons and broadened our peripheral vision. One of the great things about global investing is that it forces us to be much more unconstrained in our thinking. Our universe is much broader because it is global and the onus to be more aware of alternatives is on us.
John Cole: One of the advantages in our fund approach is that each portfolio manager brings global investing experience to the table, not just experience within their boundaries. Our portfolio managers based outside the United States are as likely to have experience with a U.S. company as are our U.S. portfolio managers, and those of us in the U.S. are equally likely to discover an overseas opportunity.
George Maris: With our global approach, we view a portfolio holistically, rather than taking a sleeved approach based on region and country. We believe this approach provides a much more attractive risk/reward profile.
Mark Sodergren: An example of George’s comment is the oil services industry in Europe. If you run a sleeved approach there, you may not serve investors well when your best operators are in the U.S., which is where you want to invest your risk budget. We look for the best companies, we won’t let regional boundaries or narrow sectors affect our thinking. One advantage we now have is the increasing consistency of accounting standards across borders.
George Maris: We seek our return primarily from good stock selection. Recognizing periodic opportunities to overweight or underweight sectors does occur, but our fundamental belief is that sector rotation strategies are unlikely to add value consistently and are certainly not our focus.
George Maris: As mentioned earlier, we have a very disciplined approach to portfolio construction that allows us to look at the world in terms of sectors and best-in-class stocks rather than regions. Just because we look at drivers on an industry basis does not mean we ignore regional differences and drivers, but they are not our first line of analysis. On the fund side, we do have some limitations and rules surrounding sector representation and we have to exhibit common sense.
Mark Sodergren: Although we keep a global focus, we do not let regions get too overweighted or underweighted. We let our natural bottom-up selection process drive a tilt one way or the other. When you aggregate up, you get a natural bias in favor of a region that is attractive, rather than an arbitrary weighting or overriding model that is static. It would be nice to allocate best-in-breed selections across the globe, but you tend to get a natural overweight in a region when that region is stronger than others.
On the other hand, searching globally for opportunity sets tends to provide us a lot more alpha potential, while at the same time diversifying and managing risk so that risk-adjusted returns might be enhanced over time.
George Maris: Ultimately, we strive to add alpha through stock selection without geographic constraints.
John Cole: We believe fundamental factors drive share prices and they are best analyzed within an industry framework. Within this framework, we use a time-tested model to identify companies that have attractive historical characteristics around their capital deployment, earnings quality and have reasonable valuation. We then put a great deal of thought into developing our investment thesis and appropriate metrics to forecast what might happen in the future to increase the stock price.
To summarize, we invest by focusing on good companies, researching them to develop our investment thesis and using sophisticated risk tools to build portfolios intelligently.
John S. Cole is the head of global active equities at Northern Trust. Previously, he served as managing director and COO at Lincoln Capital Management, executive vice president and chief equity investment officer at Boatmen’s Trust Co., and vice president and treasurer at Cowles Media Co.
George Maris, CFA, is a senior portfolio manager at Northern Trust. Previously, he was a senior portfolio manager with Columbia Management Group where he managed large- and mid-cap core equity portfolios. Before that, he was a portfolio manager and analyst at Putnam Investments.
Scott R. Ayres is a senior product manager at Northern Trust. Prior to returning to Northern Trust in 2003, he was director of institutional investments at Banc of America Capital Management. He also has held positions at Signet Asset Management and Wilmington Trust Co.
Mark C. Sodergren, CFA, is a senior portfolio manager in the quantitative active team at Northern Trust. Previously, he was a portfolio manager at Barclays Global Investors, focused on active U.S. large-cap strategies. He also spent six years at Citigroup Asset Management as a portfolio manager and researcher.