The case for investing beyond the US
- The US has performed strongly for a long time, but the case for investing internationally has grown
- Diversification is a fundamental principle of good investing
- Taking a bottom-up approach allows us to spot growth companies throughout the world
All investment strategies have the potential for profit and loss, capital is at risk. Past performance is not a guide to future returns.
The US currently represents 60 per cent of the global equity market. This means US investors with an extreme home bias are ignoring 40 per cent of the equity universe. In truth, doing so over the last 12 years would have worked out well for you. These bouts can be significant, but markets are cyclical, so it’s unlikely this will last forever.
For example, consider the ‘lost decade’ for US stocks that started in the early 2000s. Between 2000-2009, the cumulative total return for the S&P 500 was down 9.1 per cent versus a 30.7 per cent rise for the MSCI ACWI ex US.
There’s a long history of throne-swapping between US and ex-US stocks (see chart). As this is one of the longest periods of relative strength in the past 20 years, after such a lengthy period of outperformance, history tells us this can change. Investors should think twice before giving ex-US assets the cold shoulder, since trying to time regime changes is very difficult without the benefit of hindsight. There are strong reasons to consider both US and ex-US equities for asset allocation.
US and international markets tend to move in multiyear cycles
Relative performance of US S&P 500 versus international developed markets based on five-year rolling returns*
*Relative performance represents the S&P500 Index's returns minus international developed markets' returns (MSCI World exUS)
Source: Refinitive Eikon monthly data from 02/06/1975 to 01/06/2023
Overweighting US equities fails to show GDP growth relative to index representation. The US represents 60 per cent of the MSCI universe yet accounts for 24 per cent of global GDP.
Seemingly settled assumptions about transnational supply chains, the free movement of goods, people, capital, trade policy, and international law are all still evolving in ways that may have implications for investors.
As new realities force changes to old assumptions, investment managers with strong fundamental research capabilities may be able to spot opportunities in the broader opportunity set that non-US equities offer.
Significantly larger and expanding international opportunity set
Rising number of listed companies...
Source: World Bank, 22 December 2022 (latest update). Data to 2019
...under-represented by the market
Source: World Bank, 22 December 2022. Data to 2021
Diversification is one of the world’s oldest principles. It is recommended in Ecclesiastes in the Bible and in Shakespeare's Merchant of Venice, and is one of the bedrocks of investing. The universe of US large- and mid-cap stocks, represented by the MSCI USA Index, comprises over 600 securities. So US investors might not be blamed for assuming there are ample opportunities for diversification and potential risk reduction in the domestic market. But is this assumption correct?
The exhibit below shows two measures of concentration for US and global developed-market (DM) equities: the weight of the top 10 constituents and the number of effective constituents in the MSCI USA and MSCI World ex US Indexes. By both measures, concentration in the US market was the highest it has been for almost two decades. As of December 2022, the top 10 assets accounted for 23 per cent of the weight of the MSCI US Index. By contrast, measures of concentration in developed markets outside the US have been stable and lower in recent years: The top 10 assets accounted for 13 per cent of the weight in the index.
US equity market showed higher levels of concentration versus the rest of the world
Top 10 constituents weight (%)
Source: MSCI. Data to December 2022
Effective number of constituents
Herfindahl–Hirschman Index, a commonly accepted measure of market concentration and takes into account the relative size distribution of businesses in a market.
1. ”Divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth.” Ecclesiastes 11:2.
2.”My ventures are not in one bottom trusted. Nor to one place; nor is my whole estate. Upon the fortune of this present year: Therefore my merchandise makes me not sad.” (William Shakespeare, The Merchant of Venice, act 1, scene 1).
3. The effective number of stocks is a measure of index concentration and ranges between 1 (for a single stock) and the number of stocks in the Index (for an equal-weighted index). It is calculated as the inverse of the Herfindahl-Hirschman Index (HHI).
US equity markets have historically been valued at a premium to other markets based on their underlying characteristics and growth expectations.
However, the valuation disparity between US and International equities is much wider than usual. The large-cap S&P 500’s P/E ratio is much closer to historical averages than other developed markets. It trades at 16.6x the 2022 consensus earnings estimate compared to a 10-year average of 17x. Various developed and emerging international markets appear more attractively valued, some trading well below their 10-year averages.
The US market's valuation is close to average whereas international is below average driven by Europe
Forward price-to-earnings ratios based on 2022 consensus forecasts vs the 10-year average
Source: MSCI. Data as of 1 December 2022. MSCI World ex USA represents developed markets excluding the US
We invest in companies, not in markets
The US is home to five of the top 10 universities in the world, generating a stream of both innovation and talent from which to build world-leading businesses. Coupled with an entrepreneurial mindset and deep pools of capital – it is no wonder many of the world’s leading companies call the US home. This is, however, not a monopoly. Five of the top 10 universities are not in the US; ambitious and capable management teams are not unique to America, and ample sources of capital are available to start and grow businesses worldwide. We believe that there is an equally attractive international opportunity set.
Our experience managing international portfolios dates back to the 1980s but investing overseas is more deeply embedded in our firm’s DNA. Indeed, Scottish Mortgage Investment Trust was founded in 1909 and has been managed by Baillie Gifford for 114 years.
As bottom-up equity investors, we invest in individual companies, not broad market indices. The International opportunity set is rich, diverse and home to a plethora of world-leading businesses.
From engineering to medicine, luxury heritage to the energy transition and the continued digitization of our world. The following pages provide some examples of the international companies we invest in, on our client's behalf, which we believe are unique.
Long-standing engineering pedigree
Atlas Copco is a technology driver, creating compressors, vacuum solutions, generators, pumps, power tools, and assembly systems that enable everything from safe medical treatment to the production of renewable energy.
Keyence develops and manufactures factory automation equipment, ranging from sensors, measuring instruments, vision systems, laser markers and digital microscopes.
Shimano’s history originated in 1921, when its founder, Shozaburo Shimano, opened a small ironworks in Sakai, Osaka. Today, Shimano sell bicycle components and fishing tackle. The company has roughly 70 per cent global share in bicycle gears and brakes.
Nidec is rapidly developing a range of eAxle systems: compact, cost-attractive electric drive solutions for battery-electric vehicles and hybrid applications.
Sustainable battery production and electrification are the strongest global trends we see in the energy sector.
NIO designs, develops, manufactures and sells premium smart electric vehicles. NIO differentiates itself through its technological innovation, such as its industry-leading battery swapping technologies, Battery as a Service (BaaS), as well as its proprietary autonomous driving technologies and Autonomous Driving as a Service.
Founded in 2011, CATL creates new energy technologies and is committed to providing premier solutions and services for new energy applications worldwide.
Nexans produces and installs what are known as ‘energy highways’, electrifying the future. These cables allow the transmission of much larger quantities of electricity, which is particularly important given that electricity demand is expected to increase by more than 40 per cent by 2040. Considering the limited resources available, distributing more electricity will be essential for the energy transition.
Building a sustainable battery ecosystem is one of the greatest puzzles of our time. Still, the Swedes are swiftly putting the pieces together to create a battery ecosystem that is setting global standards. Northvolt is Europe’s first homegrown EV battery production facility.
Moore’s Law is the doubling of computing capability every 18 months. We can intuitively understand what a doubling of computer power is. What we’re very bad at understanding is the implications this will have across swathes of our economy.
The Dutch giant ASML manufactures complex lithography systems for the production of microchips – necessary for everything from medical equipment to cars and smartphones. It is the largest supplier to the semiconductor industry.
TSMC created the semiconductor foundry business model in the late 1980’s. It has since grown to dominate the market for the most advanced chips for various applications including smartphones, high-performance computing, the Internet of Things (IoT), automotive, and digital consumer electronics.
Adyen is a payment processing company that gives merchants multiple ways to accept payments on a single platform, including a payment gateway for online payments, point-of-sale for in-person transactions and integration abilities for in-app or mobile payments.
You can’t fake it
Ferrari is synonymous with classic sportscars and is one of the most enduring luxury brands. Ferrari’s product line-up will evolve over the next decade – with the first pure electric vehicle launch in 2025 to go with a growing portfolio of hybrids.
When you hear the name Hermès, the chances are you will think of some of the most famous handbags: the Birkin, the Constance or the Kelly. Hermès has managed to achieve cult status of its bags to such a degree that price increases fuel greater demand – an excellent example of ‘a Veblen good.’
Kering was founded in 1962 and was originally involved in wood trade negotiation and construction materials. Through a series of acquisitions, today Kering manages the development of renowned fashion houses, leather goods and jewellery including Gucci, Saint Laurent, Bottega Veneta, and Alexander McQueen.
Richemont’s prestigious ‘maisons’ are recognised for their craftsmanship, creativity and excellence in high-quality jewellery, watches, fashion and accessories. Richemont’s luxury goods interests encompass some of the most prestigious names in the industry, including Cartier, Piaget, Alaïa, and Montblanc.
Our understanding of biology is accelerating and could revolutionize the field of medicine
Genmab specialises in antibody therapeutics, with the aim of improving the lives of patients. They have a proven track record of discovering and developing innovative medicines targeting cancer and other serious diseases.
Sartorius is a leading international partner to the biopharmaceutical sector. Its products are integral in supporting lab workers to develop and produce drugs safely, timely and economically. It has been annually growing revenues by double digits on average, and regularly expanding its portfolio through acquisitions of complementary technologies.
Beyond providing the technology behind Pfizer’s mRNA Covid-19 vaccine, BioNTech focus on therapeutic areas including malaria and tuberculosis.
Tilting the odds in your favour
The international opportunity set is a vast and exciting hunting ground for a bottom up stock-picker. Our aim is to find and invest, on our client's behalf, in those world leading companies that can significantly grow their businesses over the next five years and beyond.
Written by Paul Taylor and Katie Muir
The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
This communication was produced and approved in February 2023 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
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