It’s easy to invest in a global tracker and think you now have ‘global’ covered, but the reality is much more nuanced than some investors might think.
While global equity strategies have an important role to play in many portfolios, investors have to make sure they understand what they’re buying, as they might in fact be allocating to a much smaller area of the market than they originally thought and be exposed to early disappointing returns going forward.
According to Chris Rush, investment manager at IBOSS, the simplicity and cost-effective nature of global trackers “certainly warrants them a place in almost any portfolio”, but one should not be limited at just that.
“It is important for investors to recognise that global trackers tend to be heavily weighted toward the world's largest companies, many of which are US firms,” he said.
“If these firms outperform, an investor holding a global equity tracker is likely to have performed very well, but passive investors could be disappointed with their overall returns if a broader selection of regions or small-to-mid-sized companies outperform large US-based firms.”
For this reason, Rush argued that a combination of active and passive is “the most sensible approach”, with his core portfolios currently holding 25% of their global allocation within passive funds, although that’s won’t work for everybody.
In particular, passive vehicles might not be the right choice for investors who don’t want the concentrated positions they come with, or who fundamentally believe active managers will outperform. In other cases, they might already have a sizeable chunk of their wealth in global equity passive vehicles via other investments, such as pension schemes.
If that’s the case, they’ll want exposure to a more diverse range of regions and to look at other funds to supplement a passive approach to global equites.
Ben Mackie, fund manager at Hawksmoor Investment Management, share some similar concerns.
The US’ share of the global equity market is around 60% to 70%, depending on the index. That in turn is dominated by the biggest five to 10 US stocks, which have also become a more dominant part of the US market.
In buying a global tracker, investors are therefore buying 70% US equities and within that taking “very significant exposure to a small basket of stocks”, so need to “be aware of what they are actually owning”.
“People who suggest that active management is rubbish are extrapolating from the post global financial crisis backdrop, when the market was being led by a handful of mega-cap tech stocks in the US,” he said.
“From our perspective as valuation-conscious investors, the US market is very expensive at levels that are consistent with early disappointing returns going forward. With that in mind, would we want to have a shedload of exposure to US equities that we think are expensive? No. So would we want to invest in a global tracker? Also no.”
Mackie, an “unashamed advocate of active management”, also highlighted that, for some people and at some points in time, global tracking “might be the right way to go” – mainly because it offers access to liquid markets at a low cost, which is “one of the few things that is guaranteed in the world of investments”.
Still, at this point in time, with “a huge amount of valuation dispersion within individual markets” (meaning the gap between the most expensive and the cheapest parts of the market), a more active approach is more interesting, he argued.
“High levels of valuation dispersion create a fertile hunting ground for active managers to try and add alpha. There's some really interesting areas out there at the moment that are underrepresented in global equities and therefore would be underrepresented if you're accessing the market via global tracker,” said the manager.
These areas would be UK mid- and small-caps, where “so much bad news is already priced in”; Japanese small-caps, where the corporate governance reform story is gaining traction; and Asia, where the bigger names in the market are trading on expensive valuations but there’s “lots of interesting ideas below the surface”.
But not everyone agreed. For Tom Sparke, investment manager at GDIM, a passive is “ideal” for a one-stop equity allocation but he uses both active and passive for certain asset classes.
“In many of our portfolios, we have a base of passive global equity exposure and complement this with a fund that taps into a certain theme or fulfils a specific need in a portfolio. For example, we have used global infrastructure funds in the recent past, as these give exposure to a major macroeconomic theme as well as a reliable and low volatility income stream,” he said.
An area which he finds would be “most appropriate” for active funds is global equity income.
“We have used an actively managed strategy in this space in the Redwheel Global Equity Income fund, as this is a concise, high active share fund that we have faith in to deliver consistent income and steady growth in total returns.”
In the passive space, most funds are structured on a market-capitalisation basis so the largest companies represent more of the portfolio, he said.
“As such, a base allocation to global equities is achievable through a passive fund and we have found that the Legal & General Global 100 fund is a useful tool for this.”
Ayesha Akbar, multi-asset portfolio manager at Fidelity International, said that there is no single ‘correct’ approach to equity allocations.
“We see a preference for global exposures particularly when equities are a smaller proportion of overall portfolios, when investors are focused on simplicity of structure or when they seek ‘core’ exposure through global strategies alongside more opportunistic or satellite exposure to specific regions, sectors or themes,” she said.
“In terms of implementation, starting with 'active or passive?' is putting the cart before the horse. Both approaches have merits and drawbacks. A better place to start is focusing on what an investor's objectives are, and only then consider the best approach to meet those objectives.”