Super Six Series: Global Equities – Smarter Exposure to Global Growth

Hello, I'm Darren Connolly, CEO at Investment Markets, and I'd like to welcome you to The Super Six. Six experts, six asset classes, and one outlook for your investment portfolio. Before we start, however, I need to remind you that this is all general advice and general information only, and nothing that you see or hear should be construed as an investment recommendation. You will need to decide what is right for you. With me today is our expert on global equities, George Clapham, Director at EQT, 8Bays Global Fund. Welcome, George.

Thank you. Thanks for having me.

What have been the main themes in global equities? There's never been so many column inches about global equities, I think. What have been the main themes in this asset class in the last 12 months?

Look, I think the main theme, the first big theme has been the impact of the change in government in the US and the Republican Party's economic and fiscal policies. And that is filtering through the globe. Obviously, you know, tariff policies are one issue, but how are they going to fund a deficit? But also things like defence policy and increased expenditure in NATO. So I think that's what the market is is focused on almost entirely at the moment.

And there seems to be an announcement nearly every day.

And we're getting towards the end, hopefully the end of the announced tariff regimes across the globe. So yes, that's one aspect of their policies, but there's also the policy on defence and shifting the budget, or their budget, or maintaining that budget, but also shifting the emphasis to other NATO countries, which is having an impact on fiscal policy expenditures for all countries, particularly in Europe.

And may actually have an impact on Australia at some point.

Certainly, if you're moving expenditure from roughly a couple of percent of GDP towards five percent of GDP, that's a significant impact on, you know, if you look at a country like Germany, for example, that's had a debt cap and that's been removed, that has a significant multiplier effect on their economy.

And what's been the impact of all of this change, quite a lot of change in a short period of time, on investors and investor sentiment?

Well, certainly it's been a source of stimulus for, say, European equities, which have performed strongly. in the first half of this year, particularly the industrial sector and even the financial sector as well. But that also is the other theme. The other theme is obviously the first one being the Republican economic policies, fiscal policies, but secondly is the direction of interest rates. And we're seeing rate cuts in the eurozone, but not so much in the US. And that's probably going to be the theme for the second half. So those are the two sort of macroeconomic themes. But beneath that, there's a third theme, which is going to be the amount of expenditure on AI and energy infrastructure in the next 20 years, because the move into AI is driving demand for data centers, but also you've got energy transition on top of that.

Well, data centers are quite energy hungry.

That's right. And they're going from 5% of energy consumption to up to 12%, but also you've got energy transition which is going to mean more expenditure on things like the grid, which we're seeing obviously in Australia. So those are the three things that I see as driving things, the macro, fiscal policies coming out of the states, the rate at which maybe interest rates come down. And then thirdly, this drive in terms of AI and energy infrastructure, which is massive. I suppose the fourth issue is the geopolitical issues as a result of the two conflicts going on in the Middle East and Ukraine and the outcome of those in the second half of this year.

George, what separates your approach to global equities from others within this asset class?

Well, our key differentiating feature of our investment style is we are sector focused, sector and industry focused, as opposed to stock focused, individual stock focus. And we are perhaps the only global equity manager that actively uses ETFs, primarily industry-based ETFs listed in the US market. which is a one and a half trillion dollar segment of the US market. So we are sector focused, industry focused, as opposed to bottom up stock pickers. As a result, we have a much broader portfolio of stocks across a range of industries, from semiconductors to social media, and we buy those verticals, and we do that through ETFs. And there aren't other strategies that do that in Australia. Now, the benefit of having a sector ETF based investment strategy is that you remove a lot of stock specific risk. Therefore, over time, our volatility in returns should be lower and is lower than more aggressive stop picking strategies. So we're a less volatile strategy, but we're still getting returns above our benchmarks. So that's the unique strategy that we have on offer to Australian investors.

And it's in a market that is substantially larger and more liquid than what might be seen here in Australia.

Exactly. The US ETF market is a six to seven trillion dollar market. US within that industry ETFs are about 17 to 20 percent. And then there's all the passive ETFs within that and the active ETFs as well. But we focus on those industry verticals. So if we're interested in cybersecurity, we can buy that whole vertical as opposed to trying to pick the right stock within that. And our belief is that if you get the industry right, and we're seeing that industry grow, we can buy that whole industry using an ETF. And that's the beauty of ETFs. And plus, they're very low cost.

How should investors think about this asset class within their portfolio?

International equities offer a huge diversification benefit. into an asset class that is actually, if you're looking at equities, has shown to be less risky than domestic equities in terms of volatility of returns over time, but have generated higher returns. So if I look at global equities on the 10-year basis, They've roughly delivered three to four percent outperformance over domestic equities annually, with less risk. If you look at the standard deviation returns for the global benchmark, the Miski, it's been around 11 to 12 percent. And that compares with, say, 14 percent for the ASX 200. And that's in a dollars now. A lot of risk you would say is currency risk. And there is currency risk when you purchase global equities, particularly if the currency goes up dramatically or falls, you know, there's going to be volatility. But if you look at the long run returns of an unhedged global equity fund, or just the global index. So if I took the VGS, which gives you the global, that's the ETF that gives you all global equities, those returns have been significantly better. And this has been on a 10, five and three year basis. And in fact, I think the last 12 months as well.

So that's not a story that's usually sort of front and center for Australian investors who maybe overweight their domestic market.

Yes, if you overweight the domestic market you are, and let's say you buy the index and the index tends to perform better than a lot of managers. You are overweight banking resources, properties, stocks, because and you're also taking a position where it's a highly concentrated market with the top 10 companies occupying something like 48 to 50 percent of that index. So you have a highly concentrated market. Therefore, you've got higher stock specific risk and you've also got higher sector risk, whereas global equities Even though they say that the Mag-7 occupy a large proportion of the index, they're not like the top 10, they're not occupying 48% of the market. It's about 20%. So there's less stock specific risk and more sectors that you can invest in, which are growing at a faster rate. And the reason global equities have outperformed over that period of times is earnings, earnings and earnings. Earnings growth has been greater in international equities because there's been a greater bias towards tech companies which are growing their earnings faster. But that is the long-term driver of equity growth and equity returns is earnings.

So the opportunity looks like it's overseas, George.

I think there still is the opportunity to shift more of one's portfolio from domestic to global equities.

So what should investors with a conservative risk profile consider when investing in this asset class?

Well, the first step, if you're wanting to get global diversification, is to look at an index-based ETF. That will give you a highly diversified fund. So if you take the VGS, which is an ETF listed on the ASX, which will give you something like a thousand, over a thousand stocks within that portfolio at a very low cost. I think it's only about 18 basis points. That is the most diversified global fund that you can purchase. And that has tend to outperform most asset managers that are charging much higher fees.

They don't want to tell that story, George. We don't want to tell that story.

And that's our benchmark. This is what I have to beat. So that is the first step. That is the most risk averse way of buying international shares and getting exposure to those industries that you are underweight being an Australian.

At a low cost.

At a very low cost. The lowest cost ETF out there is the S&P 500 or the IVV ETF. And that gives you exposure to the 500 top American companies. And I think that's got a management fee of four basis points. So those are two low risk ways of playing international equities. They do have hedged versions of that. But I don't believe that hedging adds value over time. And if you look at the returns of hedged and unhedged global equity funds, unhedged funds tend to do better with lower cost.

George, what should investors who have a more balanced risk profile or are maybe just thinking a little bit longer term, what should they consider when investing in this asset class?

I think when you've got a view that you want to move offshore. You want to move offshore and take advantage of those industries that you're underweight being an Australian. So when we talk about those industries, you can say technology, but we don't view technology as an industry. you might want to consider the fact that there are growth industries like semiconductor, cybersecurity, robotics. There are different verticals within that industry. Which don't exist in Australia. Which don't exist in Australia. And that's what we do. We try to offer people exposure to those industries which are growing. Everyone says about technology, but one of the interesting industries at the moment is energy transition. and the whole power story, because you need power and energy to drive data centers to transition the energy grid from a carbon-based one to a non-carbon-based sustainable energy. So we pick sectors in that, which are, we've got an ETF called Grid, which gives you access to all of those companies involved in, switching technology and building cooling and heating plants and building transformers that go into power stations. So, you know, these are companies like Siemens, companies like, well, even Nvidia, because they're providing the underlying drivers of the robotics industry, for example. So you want to go into those industries and get more weight of that. You don't want to go offshore and just buy more banks, for example, because you've got plenty here. So our strategy is more about delivering more growth than you would in your domestic portfolio.

So if you have a more balanced view, you get a more longer term view, there are more opportunities in that vein. Obviously, that's what I'm hearing.

Yeah, certainly. And the opportunities, industries are changing. And we want to take advantage of those opportunities of change. So you take, for example, the healthcare sector. Within the healthcare sector, there's biotech, there's pharmaceuticals, there's medical devices, there's healthcare services. Now those industries will change with the advent of AI because AI is helping drug development, for example, improving the speed of which drugs can be developed and delivered. So these are going to be transformative technologies going into existing industries, which will create new drugs and new opportunities.

And massive value for the companies that can take advantage of that.

There will be value, but there will be winners and losers. And our point is that when you buy an industry vertical through an ETF, you are going to get the losers. But if the industry overall grows from say a $500 billion industry to a $1 trillion industry, overall you will have the winners. And the ETF is a great way of actually picking that winner without having- To pick the winner. Spending a lot of money on analysts to try and find that winner. And our strategy has actually shown that picking the vertical does work.

So, George, what is the outlook for the asset class for international equities? What really gets you excited about the forward outlook?

Well, I always go back to my original answer that equities are driven by earnings overall. So the long term performance of equity markets has been driven by real earnings growth. So when I look at international markets, I look at where the earnings growth is happening. and where the earnings growth is happening at the moment is in the US in particular, it's been very strong. And I see earnings growth being quite resilient. In fact, you know, two of the largest tech companies reporting earnings growth, well in excess of expectations. So that was Microsoft delivering 18% revenue growth versus 14% expected. and Meta reporting 22 percent top line. And these are large cap companies. So it's earnings growth, earnings growth and earnings growth. And this is this is the early stages of the enablers delivering that growth in generative AI. And this is impacting their returns. Now, these this generative AI revolution is going to, as I mentioned, affect all industries. So if you take the healthcare ones, like I took healthcare as one, but if I took transport and autonomous vehicles, the impact of autonomous vehicles or autonomous transport, I'm not just saying taxis, but other factors that can lower transport costs by up to 80%. Now, the multiplier effect of lowering transport costs because you're taking out labour has a huge impact on, you know, suddenly it only costs $5 to get a taxi into the city to go out versus $20. You know, that's going to bring more people, make more people come in and have more leisure and entertainment time. Yeah, the impact of AI on robotics, on autonomous vehicles, on the whole transport industry is going to be quite significant. So I'm actually quite positive. as to the impact of these technologies in terms of their effect on earnings for many industries.

So we're going to see that impact play out, transport, healthcare, in a swathe of different industries across the economy, and you think it's going to turbocharge earnings across many, many, many different areas?

There will be, and there will be significant risk because some industries will lose, And we've seen that in the past, if you looked at the media industry, the newsprint industry versus online advertising. is a prime example of that, a massive disruption can occur. There will be disruptions. I mean, the cost of, say, legal services could collapse dramatically. That's an expensive cog in the economy. That's an expensive issue that supports growth of businesses. So ultimately, we have to be in a position to pick those winners and losers. But I think if you're buying the vertical by an ETF, Ultimately, you should be able to pick up the winners or the major winners.

And that should benefit your investment portfolio.

It should. It should. And that's the benefit of exchange traded funds, particularly passive ones that pick up the growing income stocks as they come through.

Well, that's very insightful today, George. Thank you very much for your time and your thoughts. Thanks very much for having me, Darren. I enjoyed it. Thank you for watching. For more insights from the Super Six and to search, find and compare hundreds of investment products all in the one place for free, go to investmentmarkets.com.au.