10 ways of gaining global exposure

Australian Financial Review, February 2008

Global stock markets are a volatile and perilous place at the moment, not for the faint-hearted. But every time stock markets plunge, they also create an opportunity: cheaper stocks at more attractive valuations.

For those bold enough to want to put money into overseas shares, there are more ways of doing so than ever. International equity mutual funds have been around for years, but increasingly there are variations on the theme: regional funds, single-country funds, global property funds, funds that invest globally based on particular themes, technology funds. On top of that, there are index funds which don’t attempt to pick stocks but deliver the performance of a particular stock market, or of world markets; and now there are exchange-traded funds, which do the same thing but through the purchase of a single share rather than a fund.

There are other variables too: funds that hedge to neutralise the impact of currency movements, and funds that don’t, or actively seek to use those currency movements as a way of boosting returns. There are funds that stick pretty close to a benchmark in terms of their geographical and sector allocation, and others who ignore those benchmarks completely and just invest in stocks they like. Most international funds sold in Australia are long-only, meaning they invest in things in the hope that they will go up, but there are also long-short funds which can take short positions, meaning they benefit when a stock or index goes down.

It’s a bewildering field. So in this article, we profile 10 different products that give exposure to global stock markets, and compare their holdings, their fees and their returns. Good luck out there.

1. Vanguard Index International Shares Fund

One simple way of getting exposure to international stock markets is the use of an index fund. This is a mutual fund but, rather than picking individual stocks, it seeks to match the performance of a whole index – in this case, the MSCI World ex-Australia index, which is a commonly used measurement of world stock markets excluding Australia. Index funds are cheaper than mutual funds (the Vanguard one charges 0.9% for investments up to $50,000, 0.6% for the next $50,000 and 0.35% thereafter) reflecting the fact that you are not paying a manager to make stock selections. This fund, mirroring the index, puts 52.8% of its money into North America, 24.1% into Europe and a further 11.3% into the UK, 10% into Japan and just 1.8% into the Pacific ex-Japan. Its top holdings, logically, are the biggest companies in the world: Exxon Mobil, General Electric, Microsoft and Royal Dutch Shell. After fees, this fund lost 3.22% in 2007, reflecting the strength of the Australian dollar; over three years, though, it’s up 7.7% a year.

2. Vanguard Hedged International Shares Fund

The example above demonstrates that movements in currencies can cause you problems. The Australian dollar strengthened against most world currencies last year, and the US dollar in particular; that means that your returns from outside Australia take a hit because they are worth less when translated back into Aussie dollars. Naturally, this can work both ways: if our currency weakens, then your returns from international equities are magnified.

If you want to take the currency out of the picture, you can invest in a hedged fund. Hedging neutralises the effect of currency movements. This fund is in every other respect identical to the other Vanguard fund – fees, holdings, allocation – but in 2007 it gained 5.24%, and over three years is up 13.22%.

3. iShares S&P Global 100

Another way of investing in international markets is through exchange traded funds. These are like index funds in that they seek to replicate the performance of an index, but instead of buying a mutual fund you are buying a listed stock. This is a bit easier and quicker to get in and out of than a mutual fund, and they are in many cases cheaper still than index funds.

An example is the S&P Global 100 ETF from iShares, listed on the Australian Securities Exchange under the ticker IOO. This replicates a Standard & Poor’s index  of global large-cap stocks, each of them multinationals with a market capitalisation of US$ 5 billion or more. Its top five holdings are Exxon Mobil, General Electric, Microsoft, Procter & Gamble and BP, as of January 25. The single biggest sector it is exposed to is financials, accounting for 19.26% of the fund (although that number has shrunk in the last six months with the wobbles in the financial system), followed by energy, then consumer staples. The fund charges just 0.4% in management expenses and fees.

4. iShares MSCI Emerging Markets

Another example of the iShares range is this fund covering emerging markets. The index it replicates aims to capture 85% of emerging market stock performance. In practice, this means its biggest single exposure is to China (15.5% as of September 30), followed by South Korea, Brazil, Taiwan, Russia, South Africa, India and Mexico. Since these markets are trickier to access, it costs more than the mainstream ETF, at 0.75%. Its biggest holdings are Posco, a Korean steel company; Gazprom, a Russian gas company; Samsung Electronics; China Mobile; and Taiwan semiconductor. Its listing code is IEM.

5. Credit Suisse Asset Management International Shares Fund

 This is an example of a fund that tries to outperform an index, and stays reasonably close to that index’s allocations. In this case it’s the MSCI World ex-Australia. You can see the allocation of that index in the Vanguard profile above; Credit Suisse’s allocation is 47.5% North America, 35.2% Europe and UK, 13.9% Japan, 2.5% Asia and 0.9% cash or other. So, comparatively, Credit Suisse is underweight North America and overweight Japan and Asia, but is broadly in line with the benchmark. Its holdings, though, look quite different from any index fund: the top holding at December 31 was Potash Corp of Saskatchewan, a Canadian company, followed by Barrick Gold and Nintendo.

Like many funds this comes in a few different forms, depending on whether one has bought it direct, through a platform, and how much one invests. Under the Select Investment range – which requires you to have invested a total of A$25,000 across any number of Credit Suisse funds – the management costs are 1.15% a year, with a 0.36% buy/sell spread. Net of fees, the fund returned a 1.46% loss in 2007 – better than the benchmark, which was a 2.6% loss, but still a loss. Over three years, it’s returned 7.83%, which is less than the benchmark at 8.26%; over five years it looks better, with 7.17% returns versus 6.72% from the benchmark.

6. Hunter Hall Value Growth Trust

Hunter Hall is an example of a manager who does not track an index. Indeed, when you buy a Hunter Hall fund, you are counselled in the product disclosure statement: “DO NOT invest in the trusts if you expect to achieve index-or-better returns at all times. It is a certainty that the trusts will underperform their benchmarks for periods of time.” The theory is that managers should be free to pick stocks they like regardless of how correlated they are to a broader market benchmark, and that by doing so, they’ll do much better in the long run. Despite some recent wobbles the manager has plenty of ammunition to back its argument: $10,000 invested in the MSCI World Accumulation Net Return index in Australian dollars in May 1994 would have been worth $25,683 by the end of December 2007; in the All Ords it would have been worth $52,788; and in the Value Growth Trust, $107,628, four times higher than the global index.

Its top holdings are hardly household names. They include Samchully, a Korean machinery company; Woongjin Thinkbig, a children’s educational material producer; and PA Resources, a Swedish gas exploration group. Unusually for global equity funds, this one can also invest in Australia.

Funds like this tend to charge higher fees than mainstream products. The management fee is 1.6%, and there is a performance fee of 15% of any return over the All Ords over six monthly periods. One curiosity of the fund is that it invests in global stocks, but calculates its performance fee against an Australian benchmark.

7. Platinum International Fund

This is another fund which, although it sets out to outperform the MSCI index, doesn’t have to mirror its allocations in any way. As with Hunter Hall’s fund, it’s worked: since the fund was launched in 1005, the MSCI AC World index has done 148.3%, and the Platinum fund 574.5%.

On December 31, its top holdings were Microsoft, Siemens, Bombardier, Hutchison Whampoa and International Paper. Compared to regular global indices, it is dramatically underweight the USA and overweight Asia: North American accounted for 23.8% of the long positions in the fund (that is, those that benefit from the stock going up), less than half the MSCI index; and Asia accounted for 18.9%, several times higher than the MSCI weighting. Platinum funds are allowed to take short positions, which benefit from a falling stock or market, and at the end of December it held shorts on four stocks and six indices. For this reason the Platinum fund is sometimes referred to as absolute return or even a hedge fund, although definitions of these terms vary. Fees are 1.54% a year and the minimum initial investment is A$25,000 unless you buy it through a platform.

8. Zurich Global Thematic Share Fund

This is an example of a fund which applies a particular investment idea to a global portfolio. Zurich says the fund is “based on the belief that there is one global economy”, and “emphasises global themes and relationships rather than geographic regions.” It combines top-down (or thematic) ideas with bottom-up (based in individual stocks) techniques.

Zurich isn’t actually the one doing the managing: it’s Lazard Asset Management. The themes Lazard have come up with have some curious names, among them “big pharma,”, “antimatter”, “feeding monsters” and “synchronised maturity”.  “Ultimate subcontractors”, for example, focuses on lowest cost producers, companies that have access to basic materials and therefore are able to conduct one-sided price negotiations – oil companies, for example.

These various themes lead to an interesting mix of stocks. At December 31 the top holding was Hong Kong Exchanges, followed by the Swedish power and automation technology group ABB, then US oil major ConocoPhillips and China Shenhua Energy. The US is the largest market in terms of allocation, though well below the MSCI World index weight; the fund comes out heavily overweight Asia (15.8% of the fund), underweight Europe and about flat on Japan. The fund has beaten the MSCI index consistently, delivering 6.3% in 2007 and 10.2% over five years compared to -2.4% and 6.8% respectively for the index. Fees are 2.05%, with a 0.1% buy/sell spread.

9. IOOF/Perennial Asia Trust

In addition to international equity funds, it is possible to invest in individual regions. An example is the Perennial trust which invests in ex-Japan Asia. It benchmarks itself against an index called the MSCI AC Far East Free (ex Japan) Accumulation Index and invests in a small number of stocks, usually between 35 and 65, from Asia’s bigger markets, and usually without hedging for movements in the currency. Unusually for an Asia fund, it doesn’t invest in India.

At the end of 2007 Korea was the biggest allocation, accounting for 23.6% of the fund, followed by Taiwan and Hong Kong. Its top holdings are Samsung Electronics, then the Hong Kong property group New World Development. Bought directly from the manager, the minimum investment is $25,000 (less if bought through a platform) and the fee 1.33%, with a hefty 1% buy/sell spread. Although the after-fee performance of 15.6% a year over the last five years looks great, investors may be concerned to see that the fund has underperformed the benchmark over one, two, three and five years.

10. Challenger China Share Fund

A growing number of funds exist allowing you to invest in a single foreign country. US funds have existed for many years but more recently, China and India-only funds have become more common. An example is the Challenger China Share Fund, for which the investment manager is Halbis Capital Management in Hong Kong, the asset management arm of HSBC. Like most China funds,  it doesn’t generally invest in China’s domestic stock markets, but Chinese stocks listed in other places, particularly Hong Kong. At the end of December its top five overall positions were China Mobile, Petrochina, CNOOC, China Life and Industrial & Commercial Bank of China; however, relative to China Mobile’s size and weight in the MSCI China Index, the fund is actually considerably underweight the stock.

The fund, like China itself, has been doing exceptionally well and gained 44.88% in 2007 – but it’s worth noting that the MSCI China index actually did better than that, returning 49.18%. This is the tricky thing about indices: should you feel unhappy about getting a 45% return in a year, given that it missed the benchmark by more than 4%?

The fund charges a 2.3% management fee. If you get the wholesale version of the fund, through a platform, the fee is 1.25% with a 20% performance fee levied on returns above the index.

BOX: What’s happened to the markets?

Almost every major stock market in the world has fallen since the start of this year, many of them by more than 10%.

There are two main reasons. One is the knock-on effect of last year’s subprime crisis, which in time caused problems in the credit markets worldwide. For most of last year, these problems were not reflected in the performance of equities: bonds were hit, shares weren’t. Now, though, there seems to be more of a correlation.

But the biggest reason is fear of a US slowdown or recession. Any miserable bit of economic data from the US tends to trigger selling worldwide, with a bad day in Australia or Asia generally followed by similarly bleak trading in Europe and then the States. It was after two days of continual falls worldwide that the Federal Reserve announced a 0.75% interest rate cut to stop the rot – which, at the time of writing, appeared to have been a successful strategy. Societe Generale’s extraordinary Eu4.9 billion losses from internal fraud haven’t helped either.

Strangely, though, the US is not the market that has suffered most. By January 29, the S&P500 – the most widely watched index of American stocks – was down 7.5% year to date. That’s not great, but it’s considerably better than, for example, Germany (down 14.6%), France (down 12%), the UK (down 8.9%) or even Australia (down 9.8%).

Perhaps the strangest response has been in Asia. Increasingly, economists in Asia have argued that the region has become so strong in its own right that it can withstand a slowdown in the US economy, since the volume of intra-Asian trade (that is, Asian countries trading with other countries) makes it much more independent of the developed world than it used to be. But by January 29, most Asian markets had taken a much bigger hit than the US: Hong Kong down 12.7%, India 10.8%, Japan 11.9%, Singapore 12%, South Korea 13.7% and Taiwan 10.9%. Since Asian economies are universally seen to be in better shape than the US, why should this be? One reason is momentum: investors following other investors out the door. In emerging markets like Asia, this sort of herd approach is always more acute than in bigger markets like the US.

Nevertheless, falling markets create buying opportunities, although trying to time the market correctly is an extremely difficult task. Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors, has this to say: “The last thing investors should do is panic out of markets… investing in shares should be seen as a long term proposition. While there may well be further weakness ahead, trying to time the bottom is impossible to the best approach for long term investors is to sit tight.” That’s for those who are already invested; and for people considering putting more money in? “For those wondering when is the best time to buy shares, the best approach is to average in over the next six months rather than hope to be able to predict the precise bottom or alternatively to limit the impact of getting back in too early.”