Why global equity funds need a rethink

In life as in investing, it often feels safer to keep doing what worked in the past. Yet for global equity funds, the status quo is anything but safe, in our view. 

Market capitalisation-weighted indices are set up to allocate an increasing share of the pie to yesterday’s winners, rewarding momentum. After years of US exceptionalism, the most popular global indices now represent a US-centric world view. By cleaving closely to benchmark weightings, investors may be neglecting tried-and-tested principles such as diversification and the importance of starting valuations. 

Whilst there is no single ‘house view’ at Artemis, at times there can be similarities between our funds’ aggregate positioning. Within our global offering, the Artemis Global Income and SmartGARP Global Equity funds are currently pointing towards a similar conclusion: that opportunities are broader than benchmark indices imply and that valuations matter. They arrive there through distinct processes: macro-informed bottom-up analysis in the case of Global Income; and a systematic, factor-driven approach in SmartGARP. 

Why starting valuations matter 

Over the very long term, stock markets tend to be efficient, with share prices following the fundamental performance of businesses. However, over shorter time periods, share prices can diverge significantly from fundamentals, signalling a risk to avoid or an opportunity worth capturing.

Buying undervalued stocks and holding them as they re-rate can be extremely rewarding.

The current macroeconomic and geopolitical environment is rife with uncertainty and, against that backdrop, we think a margin of safety can provide an element of downside protection. Stocks where expectations are low and an element of bad news is already priced in have less far to fall during risk-off periods. By contrast, overvalued stocks that have been driven upwards by hype and lofty expectations appear more vulnerable. When something is priced for perfection, it does not take a great deal of bad news to knock it off its perch. 

Our valuation discipline and focus on companies whose growth potential is not fully priced in have led to portfolios that, in aggregate, are much cheaper than the market. The SmartGARP Global Equity Fund is almost 40% cheaper than its benchmark without sacrificing quality and growth. Its holdings have similar profitability and stronger balance sheets than the broader market¹. 

Meanwhile, the Artemis Global Income Fund’s macro-aware, bottom-up approach has resulted in a portfolio with a discount to its benchmark of almost 25% since inception and nearly 40% over the past five years². 

Why you don’t have to sacrifice growth to get value 

Buying cheap or mispriced stocks is not enough, in and of itself, to outperform. It is also important to own companies that can grow their earnings, cashflow and dividends faster than the market (and to scrutinise how much you are paying for that growth). 

Within the SmartGARP Global Equity strategy, a proprietary stock-screening tool is used to identify companies where analysts are upgrading their forecasts. By investing before the share price reflects that good news, this systematic strategy seeks to benefit from a combination of fundamental growth and improving valuations. 

Why emerging markets deserve a greater share of the pie 

If investors were to start with a blank sheet of paper today, it is unlikely they would choose to put two-thirds of their portfolios into one country – especially if that country had one of the world’s most expensive stock markets. 

Stepping away from market capitalisation, other data sets highlight the dominant role of emerging markets within the global economy and put the importance of the US (which, after all, contains less than 5% of the world’s population³) into context. 

Emerging and developing economies contribute about 60% of global GDP, with almost a third of that coming from China. Looking at developed markets in isolation, the US has pole position among the world’s advanced economies, generating 37% of global GDP, but the euro area also makes a substantial contribution (29% of GDP)⁴. 

Another consideration for investors is choice. Of the 2,514 constituents in the MSCI ACWI⁵, roughly a quarter (544) are American. But more are Chinese (559)⁶. 

Getting to the heart of the matter: where can investors find the most attractive opportunities? 

From a systematic perspective, SmartGARP screens the 7,000-strong global universe of companies daily according to eight factors (including value, growth, momentum and analysts’ forecasts) before awarding companies an overall score. As many as 41% of SmartGARP’s top-scoring companies are in emerging markets, versus just 20% in the US⁷. 

At the same time, the Artemis Global Income Fund has identified a similarly rich opportunity set in emerging markets, albeit through a different lens. By combining bottom-up stock picking with a top-down macroeconomic view, it has uncovered opportunities in areas such as: commodity producers and miners benefiting from increased demand and tight supply; businesses serving emerging market consumers; and companies in South Korea, where the ‘Value Up’ programme of corporate governance reforms has unlocked strong performance. 

Why it’s time to escape the tyranny of the benchmark 

In order to perform differently to – and ideally better than – benchmarks and peer funds, portfolios need to be configured differently. To paraphrase a quote that has (perhaps mistakenly) been attributed to Einstein: the definition of insanity is doing the same thing and expecting different results. 

From a risk/reward perspective, there are many reasons to look for companies that other investors do not hold. Under-researched stocks are more likely to be mispriced and, by dint of being less vulnerable to swings in sentiment and selling pressure, they can provide a margin of safety in volatile market conditions.