powered by GlobeinvestorGold.com

Andrew Allentuck

In this Issue

Sector strategies

Andrew Allentuck

TORONTO (GlobeinvestorGOLD) — There’s a new methodology for international investing and it has little to do with country allocations.

The mantra for global investing has held that since Canada represents only 3 per cent of world capital markets, the investor who wants to have meaningful international exposure has to weight his or her portfolio with other countries’ markets.

Finance Minister Ralph Goodale removed all foreign asset limits on Registered Retirement Savings Plans in his Feb. 23 budget. The internationally-minded investor can now rebalance his RRSP portfolio without the use of clone funds. The gloves have come off in global investing. The question is no longer if one can invest retirement accounts outside of Canada, but to what extent it should be done.

Recent research shows that the budget’s proposals are too late and out of date. The increasing globalization of capital markets has made country allocation irrelevant where it counts most — the major economies of the G-7 nations, excepting Japan. That leaves the U.S., Canada, the U.K., France, Germany and Italy, moving more or less on the same path.

“Investors should look at global investing on a sectoral basis, not a country basis," said Shaun Hegarty, Montreal-based head of global equities for TAL Global Asset Management. “You invest for the industry and forget about the country,” he advised.

That’s also the conclusion of a major study of correlation in world markets. In a June 2004 research report, “How Global Is Your Industry,” Qi Zeng, who heads U.S. quantitative strategy for Morgan Stanley’s equity research department in New York, found that returns from important markets have become very integrated. U.S. and European markets now move almost in synch, Ms. Zeng said.

What’s more, the more global a nation’s industry, the more it correlates with moves of U.S. markets. The implication is that the investor with a global view need not shop Europe’s bourses.

Ms. Zeng’s study shows the U.S. markets are also highly correlated with the world as defined by the Morgan Stanley Capital International (MSCI) index, which weights national markets by capitalization. Japan is the exception to the pattern, for many of its industries are not global. As well, Mr. Hegarty notes, emerging markets cannot be expected to move in step with mature markets.

“Emerging markets may not be liquid enough to allow traders to follow the G-7. In any case, they tend to have their own issues,” he explained.

The mechanics of the increasing integration of major global capital markets is shown by recent industrial history, said Carmen Veloso, portfolio manager of the Saxon International Fund in Toronto. “When you look at Chrysler’s takeover by Daimler Benz, when you look at Alcan Inc.’s takeover of Pechiney Group in France, you see the forces of industrial consolidation,” she explained.

If regional allocation is passť, it is all the more important to play global markets by sector. To get extensive exposure to the spirits business, the investor can buy European companies such as Pernod Ricard or Diageo, Mr. Hegarty said. If the investor wants pharmaceuticals, then drug majors such as Pfizer provide it. What counts is not their nationality, but their global reach, he explained.

The case for sector investing rests on the globalization of relevant industries. American stocks dominate information technology, health care, consumer staples, energy and capital goods like machine tools. European companies have worldwide representation in energy, materials, financial services, consumer discretionary spending and telecoms, noted the Morgan Stanley study.

In contrast to the high correlations among markets of the G-6 countries, Japan has low correlations, the study observed. “The Canadian investor can buy U.S. stocks by sector and therefore get a majority of the world,” Ms. Zeng said.

Not all portfolio managers buy the argument that one can efficiently buy U.S. stocks as representatives of global business ex-Japan. “We invest in individual businesses, not in sectors, said Brian Brownlee, vice president for global equities at Beutel Goodman & Co. Ltd. in Toronto.

“It is companies, not correlations, that give us returns. Added Gavin Ivory, also a VP for global equities at Beutel Goodman, “Theories come and go, but good companies are what we are looking for.”

Correlation of Regional Returns 1988 to 2004

Values represent R²; 100 is perfect positive correlation

USA Europe Japan Pacific ex-Japan
Source: Morgan Stanley Quantitative Research.
World 85 84 67 65
USA 63 30 54
Europe 47 59
Japan 38

Andrew Allentuck writes about investments for The Globe and Mail, and reviews books on finance for globefund.com and globeinvestor.com. He is also the author of several books.

Back to top