Artisan Canvas

Are You Getting the Right Non-US Exposure?

Tepid economic growth in the post financial crisis decade left investors searching for companies that could stand out from the market by disproportionately growing their profits. The technology-centric US economy became the preferred destination for capital, with profit growth far exceeding its non-US peers (Exhibit 1). This rise in profits combined with more multiple expansion drove US equities to deliver over 600bps of higher annual returns and higher returns on equity (Exhibit 1). That said, it might be appropriate for investors to sharpen their pencils and give their non-US equity exposure a closer look given the price being paid for US profit growth appears a bit stretched today, and past performance is not indicative of future results (Exhibit 2).

Exhibit 1: Superior EPS Growth and Multiple Expansion Drove a Decade of US Equity Outperformance

	EPS Growth CAGR	FY2 PE Multiple (7/1/2009)	FY2 PE Multiple (2/29/2020)	Average Annual ROE	Average Net Debt/ EBITDA	Total Return CAGR1
MSCI USA	7.9%	12.0x	17.2x	14.4%	1.6x	13.9%
MSCI ACWI Ex US	2.2%	12.2x	13.2x	10.4%	1.8x	7.8%
Variance	5.7%	-0.2x	4.0x	4.0%	-0.2x	6.1%

1.Represents trailing twelve-month data from 6/30/10 to 2/29/20.
Source: Artisan Partners/FactSet/MSCI. Figures represent the economic expansion from 7/1/09 to 2/29/20. Past performance is not indicative of future results.  Current performance and data will vary from what is shown.

 

Exhibit 2: The Price Being Paid for Domestic Earnings Growth is Above Its Historical Average Today

Source: Factset/MSCI. Past performance is not indicative of future results.  Current data will vary from what is shown.

 

A Pervasive Home Country Bias

US dominance appears to have led US financial professionals to steer their clients to invest primarily at home. As of June 2020, US financial professionals have allocated roughly 75% of their clients’ portfolios to domestic equities (Exhibit 3). While it is difficult to determine what the appropriate mix should be, particularly given varying degrees of risk tolerance and suitability, average returns over the past decade may have been strong enough to lead financial professionals to prefer US equities. However, this focus on US investing could have led these same investors to overlook investment opportunities in non-US domiciled companies.

Exhibit 3: Non-US Equity Exposures Do Not Align with GDP Distribution

Source: BlackRock as of August 25, 2020.

 

Top Performing Stocks in the MSCI AC World Index Have Been Domiciled Outside of the US

Since 2010, the majority of the top 50 performing stocks in the MSCI AC World Index (ACWI)—designed to track broad global equity-market performance and a benchmark for $4 trillion of global equity assets—were domiciled outside of the US (74% on average for any given year). These same non-US companies within the top 50 tended to be in the consumer discretionary, industrials and financials sectors; located in emerging markets; mid-caps; and these stocks delivered average annual total returns well ahead of US equities in general (Exhibit 4).

Exhibit 4: MSCI USA Total Return vs Non-US Equities in the Top 50 Performing ACWI Stocks

Source: Artisan Partners/FactSet/MSCI. As of 31 Dec 2020. Past performance is not indicative of future results.

 

Drawbacks of Investment Strategies Closely Resembling the ACWI

Attempting to gain exposure to the top performing non-US stocks by investing in vehicles or strategies closely resembling the ACWI’s market-capitalization and country allocation methodology has its drawbacks.  Foremost, this approach lacks flexibility to adjust to broader market conditions and company specific developments. The ACWI’s capitalization-weighted approach—which is mostly static year-to-year—does not always align with the opportunity set. In addition, US domiciled companies represent 60% of the weight in the ACWI, and nine of the top 10 largest holdings have been US-domiciled over the past decade. With the top 10 holdings representing roughly 15% of the overall index and primarily concentrated within the US information technology sector, investors who are seeking to diversify their portfolios towards a global allocation could be unknowingly overexposed to US-domiciled companies. Lastly, the ACWI’s top 50 performing non-US stocks had an average weight of just 0.6% over the past decade, limiting their contribution to the index’s overall performance.

Unconstrained Fundamental-Oriented Investment Strategies Could Help

An unconstrained bottom-up global investment strategy could provide a better way to gain exposure to non-US domiciled companies. Over the past two economic expansions, profit growth has been the primary driver of stock prices. This bodes well for skilled investment managers who can identify company-specific profit drivers through bottom-up fundamental analyses—oftentimes, this approach includes finding companies with above-average growth potential, wide competitive moats, reasonable valuations and/or identifiable catalysts to unlock shareholder value.

The non-US opportunity set for equities is also larger and generally less researched. With ~40K companies outside of the US (vs. ~4K in the US), a bottom-up oriented strategy could cast a wider net when not constrained by an index’s set universe. Compared to US companies, other developed market companies are covered, on average, by two fewer sell-side analysts and three less for those in emerging markets. This can enable bottom-up oriented managers to invest in more inefficiently priced companies. When effective, an unconstrained, global approach can enable investors to differentiate returns relative to a benchmark index, as opposed to a passive global strategy, which will generally be in line with its returns.  However, with greater reward, may also come greater risk, and investors should do their homework to find the right manager with a track-record of success who will meet their investment criteria.