Global Diversification Trick

by | Jul 9, 2009 | Multi Currency Investing

Here is a global diversification trick that may do well in the likely global economic scenario ahead. Buy good value shares internationally as markets dive during the summer dip.

Global equity markets have been in a bear market rally for six months but are now hitting the summer blues due to seasonality.

Share prices will probably drop now. Chances are there will be a strong global equity slump at least through October 2009.

This will create extra value in equity markets and provide good opportunity to pick up high value long term.

The bear market is likely to carry on until 2012-13, but good value shares acquired during dips are more likely to spike early and have extra potential after the bear ends.

Now through October 2009 could be a good time to invest in high value shares for long term appreciation.

But which shares… in which markets?

One way to approach this is to look for extra value created by inefficiencies in markets… to find markets where the values are best.

Statistically this is the best way to be absolutely sure of the best long term returns.

There are numerous investment managers who use very strict valuation criteria (usually based on dividend yields, cash flow, price earnings) to spot the best value markets.  They then try to apply similar criteria to select good value shares in the good value market.

The next goal is to decide how much should be weighted in major market and how much in emerging markets.

Here is a comparison of the Morgan Stanley Major Market versus Emerging Market indices.

The MSCI World Index is a market capitalization weighted index that measures the equity market performance of developed markets.  It includes 23 developed market country indices : Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States.

The MSCI Emerging Market Index includes Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.

MSCI Indices performances.  Total per annum return over:

Major               Emerging
15 years    4.10%                   5.41%
10 years  -3.85%                   9.11%
5 years    -2.77%                  11.16%
3 years    -10.81%              -00.17%
1 year      -20.81%             -27.53%
3 mos.      14.30%               27.53%

Regardless of the time frame observed,  the emerging equities almost always seriously outperformed major markets… but as a class they also dropped further in the 2008 downturn.

Here is a year-on-year comparison for the past five years.

Major                   Emerging
2003  10.74%           29.63%
2004    6.46%           16.51%
2005   26.17%           54.41%

2006     7.40%          18.23%

2007     -1.66%         25.71%
2008   -50.30%      -37.64%
2009      5.39%         34.79%  3 months

This history suggests that emerging markets deserve a substantial ranking.

However before becoming too aggressive in over weighting emerging markets, we have to keep in mind two thoughts.

First economic thought. The last 15 years has been a catch-up era when the investing world caught on to the idea that emerging markets offered great opportunity.

Second economic thought. A great deal of emerging growth came from debt financed exports to the developed world. This leaves emerging economies holding huge amounts of debt for customers who may not be able to repay the debt nor continue to buy the same volume of goods as before.

The easiest way for investors to invest in good value during dips is via a value mutual fund.

You can select a value major market fund, a value emerging market fund or a value diversified fund.

The benefit of a value diversified fund is that the professional manager decides how much to weight in emerging and major markets.

For example, US investors can invest in the Schroeder’s International Diversified Value Fund (ticker symbol SIDVX).

This fund has shown that it can perform in good times as it has risen 36.08% in the past quarter ending June 30, 2009.  Though the fund invests mostly in major markets, it outperformed the MSCI Emerging Market Index.

In the last year (June 2008 to June 2009) the fund is down -24.75% and it is down  -5.85% since inception August 2006.

This fund invests mainly in a diversified portfolio of equities outside of the US based on attractive valuation.

The manager aims to capture historically high returns from value but with lower risk than the Morgan Stanley Capital International EAFA Index (Europe, Australia, Asia and Far East) as this is where a large portion of the fund’s investments are made.   However, the fund can invest in any country in the world, including emerging markets countries.

Currently 14% of the assets are in emerging markets.   Normally not more than 25% of the assets will be in emerging markets.

As with most value funds the the portfolio construction process is a bottom-up process, selecting stocks with high dividends and strong cash-flow.

The Fund will normally invest at least 65% of its assets outside the US but no more than 25%  in any one country or group of countries.

This is a small (about $8 million under management), new (started 2006) no load fund.  There is a 2% redemption fee however. The minimum investment is $2,500.

The most recently reported top ten holdings in the fund were:

Equity                                                Traded            % of Portfolio

1. Quanta Computer Inc.                      Taiwan                  0.54%
2. Hong Kong Land Holdings LTD    Hong Kong           0.51%
3. BCE Inc.                                              Canada                  0.51%
4. Telekom Austria AG                         Austria                  0.51%
5. BP Plc                                                  England                0.50%
6. Singapore Airlines LTD                   Singapore             0.50%
7. Telecom Italia SPA                           Italy                        0.49%
8. Royal Dutch Shell Plc                      Amsterdam           0.49%
9. Telefonica SA                                    Spain                       0.49%
10. Delhaize Group                              Belgium                   0.49%

The country breakdown of the fund’s portfolio is

Japan           15%
UK                10%
Emerging    14%
Europe         41%
excluding UK
Pacific excluding
Japan          12%
Canada         8%

Schroders, a global fund management company, began in 1804 as London stock brokers and is now among the 100 largest companies listed on the London Stock Exchange.

You can learn more about the Schroeder’s International Diversified Value Fund here.

An alternative is to invest in major market value funds and emerging market value funds.

This approach gives an investor more flexibility in choosing what weighting is desired in each asset class. This also gives investors a chance to increase or decrease the weighting in either class as markets evolve.

Non US investors, for example, can invest in the State Street Global Advantage Emerging and Major market funds.

The major market diversification at this time is

Austria      14.5 %
France       13.4 %
Germany  13.6 %
Italy           13.3 %
Singapore 14.4 %
UK              14.0 %
US                8.5 %
Other           2.8 %
Cash             5.5 %

The most recent largest positions of the major market fund are:

Berkshire Hathaway Inc. 8.5%
ENI S.p.A.                           3.3%
OMV AG                              3.1%
Erste Group Bank AG      2.8%
Telekom Austria TA AG  2.6%
Total SA                              2.3%

Singapore Telecom  Ltd. 2.2%

DBS Group Holdings Ltd 2.1%
Siemens AG                        1.9%

The State Street Global Advantage Emerging Market Fund’s most recent largest positions included:

OAO Gazprom 4.3%
The Chemical Works of Gedeon Richter PLC 3.1%
MOL Hungarian Oil and Gas Plc. 2.8%
Teva Pharmaceutical Industries Ltd. 2.7%
PTT Public Company Ltd. 2.6%
Magyar Telekom Plc. 2.3%
Lukoil 2.0%
Taiwan Semiconductor Manuf. Co. Ltd. 1.9%
Bangkok Bank Public Company Ltd. 1.8%
Akbank Turk Anonim Sirketi 1.6%

The country country allocation of this fund is:

Cash         1.3 %
Turkey   14.4 %
Brazil        3.2 %
China        2.9 %
Egypt        7.6 %
Hungary  8.8 %
Israel        3.1 %
Poland      7.1 %
Russia     13.6 %
S. Africa   4.5 %
Taiwan    13.1 %
Thailand 15.2 %
Other        5.2 %

Contact Details are: State Street Global Advisors GmbH
T: +49 89 5587 8400 | F: +49 89 5587 8440

Whether you choose to use mutual funds or shares, diversified or major and emerging specific funds,  goods values are likely to appear in equity markets during the summer doldrums.


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