Global investing has become an increasingly popular strategy among investors seeking to expand their investment horizons to enhance risk adjusted returns.

Although Australian equities have a strong track record, relying solely on domestic markets can limit an investor’s exposure to various sectors, regions, and long-term structural trends. This week we explore the advantages and rationale for investing beyond Australian equities.

Global investing not only provides diversification benefits that can enhance a portfolio's risk and return potential but also enables investors to tap into additional investment opportunities in growth sectors that are underrepresented in Australia. It is therefore essential to consider the possibilities that global investing can offer.

The Australian economy has been relatively resilient to major market dislocations such as the 2000 Dot-com bubble due to the absence of a large technology sector. It also fared better than most global peers during the 2007-08 Global Financial Crisis. Furthermore, Australia also experienced a smaller contraction than many other economies during the COVID-19 global pandemic.

The resilience of the Australian economy and our local market’s unique sector mix has generated outperformance against global peers in recent years. The ASX 200 total return index has delivered a near 16% annualized return in the past 3 years, versus a 14% AU$ return of the S&P500 and an 11% AU$ return of the MSCI All Country World excluding Australia – a popular benchmark for the global share market.

Such a disparity in returns might lead investors to wonder whether they should invest in global stocks at all. But looking at a longer history makes a very strong case for investing internationally. We continue to see the case of a significant allocation to global equities as relatively compelling.

Over the past decade, we’ve seen accelerated growth across themes such as digital transformation, energy transition, online retail and cloud technology. While more recently we’ve seen a revaluation of many companies within the technology sector, the underlying trend of digitisation is here to stay.

Global shares provide exposure to the world's most innovative companies and industries underrepresented in Australia. Investors can not only participate in the long-term success of established Tech giants, gain exposure to lesser-known but crucial suppliers (such as semiconductors and microchips) to these companies, but also access emerging companies and disruptors that may become global leaders.

Australian investors have been short changed when it comes to sector diversification benefits. The big four banks represent 19% of the market. Financials overall make up 27%, while materials stocks represent 25%. In other words, these 2 cyclical sectors make up more than half of the market.

To put that into perspective, financials make up just 15% of the global market while materials have a share of just 5%. Another way of looking at this, is to consider which sectors are poorly represented in Australia. For instance, information technology stocks made up just under 2% of the local market, compared to 22% globally and 28% in the US, or much higher if you consider consumer discretionary and communication services are dominated by tech plays.

As Figure 5 shows, investing solely in the domestic market still leaves investors with disproportionate and/or unintended large bets on a couple of sectors and a handful of stocks. Exposure to global markets with different sector tilts reduces the significant sector bias observable in Australian equities and results in a better diversified equity allocation exposed to various drivers of performance.

Australia is a well-performed and relatively high growth economy versus other developed markets, that has proven relatively resilient to major market dislocations. Closer inspection reveals a lot of these aggregate trends have been driven by Australia’s unique sector mix and its unique positioning as a China beneficiary.

In the near-term, investors also appear to be less concerned about the prospect of an Australian recession. While we expect domestic growth will slow significantly this year, we also share the view that Australia can avoid a hard landing. While this is supportive for the market, its sector mix may not be as favourable going forward relative to global equities.

Australia stands a good chance of performing well in both absolute and relative terms if materials (mining) and banks do relatively well. Conversely, the long-term performance of IT holds the key to the absolute and relative performance of the global equity market given its dominant weight.

Australia’s economic performance in 2023/24 does impact our tactical market view. Domestic economic performance is particularly important in respect of the bank sector outlook, though we feel investors need to dig deeper than just broad trends in GDP and employment. The housing sector and housing-related credit growth are the areas of the economy most vulnerable to rising rates and, by extension, to a step down in growth rates. As a result, we are moderately underweight in banks, not because of concerns around recession and spiking bad debts but due to our expectation of a lack of top-line growth. This is likely to present a relative headwind for Australian equities.

The mining sector is arguably an even bigger swing factor given its inherent volatility. We have previously voiced concerns that the medium- to long-term outlook for our most important commodity, iron ore, is not looking as robust as it has been historically.

The prospect of China re-opening does offer a beacon of hope for the mining sector. However, we doubt there will be anything like the traditional impact on commodities from policy-induced growth acceleration, though re-opening might provide some short-term support for iron ore and the mining sector. Beyond a short-term sentiment boost, a structurally constrained Chinese housing sector suggests the medium- to long-term iron ore outlook is likely to be subdued. While we continue to see better supply-demand trends in energy and energy transition commodities, iron ore remains the more dominant influence on overall market performance. Subdued performance from the big iron ore miners is likely to cap medium-term upside, in our view.

A decent lift in the AU$ could crimp the absolute return on global equities. We do not see huge upside in the AU$ as a central case, though a 5-10% appreciation of the AU$ bears consideration in thinking about the performance of global versus domestic shares over the next 12 months. We continue with a partial hedge of international equity exposures on
this basis.

The near-term fortunes of the tech sector remain something of a global macro call. We think prospects of a performance pick up are reasonable on the basis that inflation eases and the Fed halts its hiking cycle, allowing bond yields to drift lower. Global equities offer better exposure to this scenario of a tech revival, and the path of inflation will be important in laying a more positive foundation for tech and global shares through 2023 and beyond.

We can attribute Australia’s relative resilience in recent years to our strong earnings performance, especially in terms of earnings per share (EPS) growth and positive earnings revisions. Zooming out over the past 10 years, however, highlights the superior earnings growth global equities have generated. US corporate earnings are the standout, growing at more than 8% per year over the past decade.

We continue to see the case of a significant allocation to global equities as relatively compelling and believe there is substantial opportunity for returns outside of Australia. Actively managed global equity funds, we think, are among the best prepared to deliver strong, risk-adjusted returns over a full market cycle and complement domestic equity allocations.