Blue Chip Issue 81

OFFSHORE
Global equity has been the best asset class for local investors
over the past decade. What has been the main driver?
That’s right. Global equity returned 19% per year in rand terms
over the past decade to end August (as measured by the MSCI
All Country World index). Part of the story is rand weakness.
The currency traded at R7 against the dollar 10 years ago. As it
depreciated, it added about 9% per year to the return from global
equity for local investors.
But the main reason has been that global equities performed
well in dollar terms, despite the March 2020 crash. The return in the
10 years to the end of August was in the top 15th percentile of all
10-year periods since 1988.
But this headline performance hides quite a divergence, doesn’t it?
Indeed. We can slice and dice it in many ways, but let’s just look at
it from a regional and a style basis.
On a regional basis, the US has led the way over the past
decade by some distance, while non-US equity returns were
much more muted. The US is by far the biggest market in the
world, accounting for more than half of the major global equity
benchmarks, whether you use MSCI, FTSE or Datastream.
The US S&P 500 returned 16% annualised over the past decade,
compared to 7% in dollars for non-US equities (the MSCI All Country
World ex US index)
Valuations: S&P 500 vs MSCI All Country World Index ex USA
But perhaps the biggest reason for the outperformance
is simply the phenomenal performance of the big Internet
platform companies, sometimes simply called the FAANGs
(Facebook, Apple, Amazon, Netflix, Google) or FAMANGs (adding
Microsoft to the list). These companies have managed to capture
increasing amounts of market share from their more established
competitors over the last decade, using disruptive business
models and technologies.
The same level of success was broadly absent in other parts of
the developed world, driven by a combination of of less permissive
regulation, less access to readily available private capital needed
to support the growth of such disruptive models during their early
stages, and less focus on delivering shareholder returns.
This brings us to the style discussion.
One of the most notable investment trends over the past
decade has been the outperformance of “growth” as an
investment style over “value”. Broadly speaking, “growth”
companies can generate their own earnings growth, often
by taking market share and therefore are not as dependent
on economic growth. The big Internet platform companies
are classic examples of growth companies, as they have been
able to deliver fantastic growth to investors over the last
10 years. Value companies are those unloved shares trading
at cheap valuations but that
typically need a strong economic
cycle to boost profitability.
Now there are several reasons for the US outperformance,
one of which is that the dollar strengthened over this
period, which does depress the returns from outside the
US somewhat. Another reason is that US economic growth
far outperformed that of Europe and Japan over this
period, while commodity producers and emerging markets
disappointed relative to expectations.
How should investors think about
the impact of low interest rates on
growth companies?
In theory, today’s share price reflects
the present value of future cash
flows a company is expected to
generate. Those future cash flows are
discounted back to the present using
prevailing long-term real government
bond yields, with lower rates making
them more valuable today. The key,
however, is that growth companies
benefit more from lower interest
rates as they have a longer runway of
expected cash flows when compared
to value companies, who tend to
enjoy expected cash flows much
sooner. Some analysts even refer to
growth companies as long duration
assets, like long bonds.
This can potentially explain why US shares outperformed
counterparts in Europe or Japan. However, low rates by
themselves are not enough, as both Europe and Japan have
lower prevailing interest rates – negative rates in fact. What
also played in favour of US stocks was a continuous ability to
deliver earnings growth and margin expansion in line or ahead
of expectations, particularly among the tech innovators.
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