Christine St Anne: Today at Morningstar Senior Analyst and Manager Research, Kathryn Young, joins us. Kathryn will be speaking at the Australian Investors Association and today she will be talking to us about some of the key points that she will be raising in her presentation. Kathryn, lovely to see you again.
Kathryn Young: Thanks so much for having me.
St Anne: Now Kathryn the topic that you will be presenting at the Australian Investors Association event is of course on global equities. So are investors actually starting to move from the home bias and now looking at global equities.
Young: We are seeing some of that. We have fund flow data, which measures the net effect of inflows and outflows in to all the funds that we cover. The fund flow data that we have is suggesting that people are looking more at global equities. We are seeing over the past recent periods, we've seen inflows on average into global equities and in contrast Australian equities on average have suffered pretty big outflows. So that would suggest that people are looking more to global equities over their home country shares.
St Anne: So it's interesting Kathryn, everyone talks about the Australian market being highly concentrated. So what are the sorts of opportunities available for investors in the global sphere?
Young: Sure. Well, of course, there is a lot more regional exposure, right. So you get some exposure to other economies, the U.S. economy, the Japanese economy, the European economy, so that in and of itself is a lot of diversification. But what I think is probably even more important is the sector diversification that you can access through global equities. I think as most people know, the Australian share market is pretty concentrated in resources and especially financially services. Whereas outside of Australia there are other sectors that are broader and deeper.
Two examples, that I like to point to are the technology and the healthcare sectors. These are big diverse, important sectors around the world, and they have – there are companies operating in these sectors that are important to Australia. There is a lot of names out there that people would recognize, like Apple and Google and Pfizer. These are the kinds of companies you can access by investing in global equities. That kind of diversification helps through a variety of market cycles. I think as many people know the resources sector tends to be highly correlated or highly influenced by activities in China, whereas other sectors maybe more robust or just behave differently throughout different parts of the cycle.
For example, healthcare is often considered a relatively defensive sector, yet with some secular growth because as the population especially in western economies age they need more and more healthcare service, even when the economy turns down, people continue to need a lot of healthcare services. So that is one sector that is broader and deeper outside of Australia.
St Anne: But of course, one of the favorite sectors in the Australian market is banking and stock because of the wonderful income producing dividends, so how does that compare with global equities. Are they – what's available for investors.
Young: Sure. That is one of the biggest criticisms of global equities. I think probably historically has been a reason that people have been hesitant to go into global equities because they do tend to be lower yielding than the Australian market. The Australian markets are fairly high yielding relative to a lot of others, especially the U.S. and Japan, fairly large markets. And if you are an Australian investor, investing in global shares, there are no (franking) credits to offset your tax bills.
So that is one of the biggest criticisms and biggest reasons to avoid global equities. First of all however, we think it's – the diversification is extremely important and the capital growth opportunities that you get from global equities are very important. Most investors need to worry about accumulating capital, growing their capital as well as the income.
Secondly, there are some strategies focused on global equities that are looking to improve the income component. So there are a few strategies, some that come to mind include Threadneedle Global Equity Income. There's also a Grant Samuel Epoch. These are unlisted funds strategy that focuses on yield. There are also a couple of ETFs and there are also some VIX operating in the global equity space. So those are some places to look if you are really concerned about getting income out of global equities.
St Anne: And of course, Morningstar premium subscribers will have access to all those particular strategies.
Young: Yes, absolutely.
St Anne: And finally, Kathryn, are there any other specific issues for investors looking to tap into the global market that they should aware of?
Young: Well, I think a big issue to consider is currency. So currency is a component that you don't need to worry about when you're investing only in local shares. Currency can represent a risk, but also an opportunity. We are big proponents of unhedged global equity exposure. We think the currency exposure is a valuable source of diversification, and over time, the data demonstrates that that has led to lower volatility. So what I mean by that is unhedged global portfolios have had lower volatility than hedged global portfolios, simply because that diversification of currencies helps dampen the volatility of returns a little bit.
We also think that's really important for Australian investors, because the Australian dollar tends to be highly correlated to equities. So if the Australian equity market is going down, in the past, the dollar has also gone down and compounded those losses. If in those situations, you have some of your assets invested in other currencies that can help damp the impact of a bear market.
So we think unhedged global exposure is really important. The risk of that position is that if the Australian dollar appreciates, hedged strategies will do better when the Australian dollar is really strong, and we have seen that over the past 10 to 15 years. The Australian dollar has appreciated and as a result hedged exposure and even local equity exposure has done much better than global equity exposure. But we think going forward, that may not be the case. Many market participants including those here at Morningstar, think that the Australian dollar is a little overvalued and may go down in the future. It's been persistently high, but it may go down in the future, and if it does, that would be a tailwind to unhedged global equity exposure. But our primary reason for saying that unhedged exposure is better is the diversification argument.
St Anne: Well, Kathryn, thank you so much for your valuable insights and helping investors take on the world.
Young: Absolutely happy to help.