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Opportunity Knocks

Summary

We hold a strong belief that equity investing is all about access to opportunity, building a diversified portfolio and achieving an outcome for our clients. Market capitalisation weighted indices get a lot of air time from their use in passive strategies but in reality miss the point or at the very least, start from the wrong point.

Opportunity Knocks
We hold a strong belief that equity investing is all about access to opportunity, building a diversified portfolio and achieving an outcome for our clients.  Market capitalisation weighted indices get a lot of air time from their use in passive strategies but in reality miss the point or at the very least, start from the wrong point.
Don’t get me wrong, I can see the point of passive investing in indices.  They are a yardstick for the active manager to beat but where many active managers fall down and underline the doomsayers of the active approach, is that they run large amounts of money, too many stocks and become index-like in their return patterns.  For some investors, getting the cheapest price to invest in equities is the most important criteria.  Getting UK workers involved in auto-enrolment via cheap passive strategies could be the best way to get those investors to start saving for their pensions.
Our own methodology for asset allocation has more to do with gross domestic product (GDP) potential than market capitalisation. The following graph from our friends at Gavekal show the key differences in the two approaches using the MSCI ACWI as the index comparison.
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Buying into a market capitalisation asset allocation process is also akin to buying what’s already gone up.  However the beneficiaries of greater growth potential in Asia may be local regional companies, global brand leaders or themes such as infrastructure companies.  Asset allocation is altogether a more holistic task today than the convenient regional market capitalisation process of a few years ago.
Perhaps a simpler way to view the opportunity in global equities is to look at the number of stocks.  After all, do we really care how big a company’s weighting in an index is?  For the unconstrained, conviction investor; it isn’t.  They buy the stocks they like and omit the ones they don’t.  Simple, it’s the large scale investors and asset managers that want to anchor themselves to an index – it means they can manage more money and satisfy their shareholders. Whose interests are they aligned with? We thought it would be interesting to look at the number of stocks available in the world, this time using the FTSE All-World Country Index.
Using their May 2015 data, the number of stocks in the index is 3,024.  Of those 3,024 opportunities the US represented 642 or 21.23%, not too dissimilar to the red bar for the US GDP weight in the graph on the previous page but way below the slightly more than 50% US market capitalisation weight according to the MSCI ACWI (blue circles).
The growth in unconstrained mandates is primarily built on opportunities as opposed to market capitalisation. Referencing an equity holding of a company that the fund manager doesn’t like but holds it as an ‘underweight’ position for fear of having too much ‘tracking error’ versus a market capitalisation index, seems illogical. As has been said before, ‘indices are fine as reference points but not portfolio construction tools’.
After screening the opportunities for their preferred criteria, there are a number of excellent active fund managers that have distilled the opportunities into a high conviction, unconstrained, index-agnostic portfolio.  They don’t tend to be the larger, by assets, providers as they tend to place the integrity of investment returns above the gathering of assets. ‘Active share’ rarely gets a mention and rightly so. They may not be household brand names.
In short, like ourselves at T. Bailey Asset Management, risk adjusted investment returns through focussing on opportunities and a diversified portfolio have precedence over asset accumulation.

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