The relative earnings growth, and multiple expansion of, the US tech sector has made it the bedrock of equity market growth since the financial crisis.
Whilst many have written about the resulting extreme concentration of tech within the US equity market, this has also impacted regional weightings within a broad global equity market index, such as MSCI All Countries World (which includes developed and emerging markets, hence “global”). On our analysis, products tracking this index had a 52 per cent allocation to the US in 2015, a 56 per cent allocation in 2020 and a 62 per cent allocation today. The figures for the MSCI World (which is developed markets only) are even more pronounced.
It effectively means that the US is the main determinant of global equity performance. If the US performance sneezes, whether the rest of the world coughs or sneezes is basically inaudible. It also effectively means that global equity is the US and the US is tech.
So for investors wanting a differentiated approach to implementing a global equity exposure, what are the options? We see four different actively managed approaches.
Option 1: Active Security Selection
This is the most traditional “active” approach, which is to select a fund manager who actively selects individual companies from around the world either relative to or agnostic of a global equity index in the quest for persistent alpha generation. There is no shortage of well-known and well established global equity managers to choose from.
Option 2: Active Regional Selection
This is another traditional approach, which is to actively manage an allocation to different countries relative to their weight in the index. Global equity fund managers can actively manage their positions to be relatively over- or underweight a particular country in the index and then implement that using either active funds or index-tracking funds for each country or region. Active regional allocation approaches are often adopted within multi-asset fund ranges.
Option 3: Active Sector Selection
Whilst “sector rotation strategies” are very popular in the US, they are less prevalent in the UK. Sector selection means linking market and economic trends with the expected returns on different business sector groupings (such as consumer staples, financials, energy and technology). Given market impacts are sometimes easier to estimate on sectors rather than on countries, the active sector selection approach makes sense. This is assisted by the extensive and long-standing academic research that explores the linkage between sector performance and different stages of the economic cycle.
Furthermore, dispersion (the difference in returns) between sectors can be far higher than the dispersion between regions. When dispersion is higher, this create opportunity for alpha. For example, in 2022 the difference between energy sector (+64 per cent) vs communication sector (-30.33 per cent) was a staggering 90 per cent plus, while in 2023, the difference between technology, the best performing sector, and utilities the worst performing sector was over 50 per cent.
So for active allocators (for whom dispersion is a friend), a sector based approach creates opportunity to generate alpha.
Whilst not common in MPS solutions, this is often an investment approach used by some private client investment managers. Whilst there is no shortage of sector-specific ETFs to implement a sector allocation strategy, there are – unfortunately – very few funds on platform that embrace a sector-selection, differentiated approach to world equity allocation. Those that do merit investigation.
Option 4: Active Factor Selection
The new kid on the block. Whilst “sector rotation” is long established, factor selection or factor “tilting” is a similar thesis that links the performance of different factor-based indices with different market regimes. Again the performance of different factors in different scenarios is well researched and deeply evidenced, making this an interesting way of implementing a view.
As with sectors, there is no shortage of factor-focused ETFs, and furthermore there are some multi-factor funds available on platforms. The key is how do they allocate to the different factors – do they use a static or dynamic approach?
Similar to sectors, the dispersion between factors can also be very pronounced. For example selecting momentum over value for years after the financial crisis made a material difference to performance outcomes, whereas in 2022, the reverse applied.
Conclusion
So for asset allocators implementing a global equity allocation, but want something differentiated, there is actually no shortage of actively managed alternatives to choose from, whether actively selecting securities, regions, sectors or factors – or a combination of all four approaches: there are plenty of differentiated active approaches to choose from.
Henry Cobbe is head of research at Elston Consulting
