In this quick-hitting video, portfolio managers from across Virtus affiliates and subadvisers address questions on timely global investing topics: why diversify outside the U.S., headwinds and tailwinds, areas of opportunity (EM debt, China, small-cap stocks, REITs), big data, and active management. Introduced by Virtus Chief Market Strategist Joe Terranova.
[00:05] Joe Terranova, Chief Market Strategist, Virtus Investment Partners
Is it time to diversify outside the U.S.?
Hi, I’m Joe Terranova, chief market strategist for Virtus Investment Partners. This is Rundown: Global Investing – the topic in which portfolio managers from Virtus will be answering critical questions surrounding whether it is time to raise investment allocations towards equity and fixed income in the international and emerging markets. Now let’s remember in the last 10 years, investors were rewarded for concentrating specifically towards the United States. But there’s been a paradigm shift – a paradigm shift in terms of monetary policy and the value of the U.S. dollar, and now is the time to give consideration beyond the United States to those investors. What follows is the answers to critical questions. Enjoy.
[00:53] Tucker Brown, Portfolio Manager and Analyst, Sustainable Growth Advisers
Biggest headwinds/tailwinds for non-U.S. stocks?
When you consider headwinds and tailwinds for non-U.S. equities, there’s definitely a balanced ledger. So, let’s start with the headwinds first, and I’d cite three interrelated factors. Number one would be inflation – pressure that it’s putting on corporate margins as well as consumer disposable income. Number two would be growth – the rise in geopolitical tensions across the world is leading to a deglobalization of the economy, which is leading to slower growth, as well as higher operating costs across the globe. And number three is the impact of interest rates – tighter monetary policies are intended to slow growth to combat inflation. They’re also leading to higher discount rates in the valuation work that we all do, which is leading to lower multiples for the stock markets across the world. And then, finally, high interest rates are stressing the balance sheets of highly indebted companies. So those are the three interrelated headwinds that I think non-U.S. equities are facing right now.
On the flip side, there are tailwinds as well. So, number one, I’d cite the combination of the moderating inflation that we’re starting to see, as well as the impact of cumulative pricing that companies have taken over the last couple of years. And the exciting thing here is that the pricing is surpassing the inflation and we’re starting to see margin recovery, which is only just beginning. The number two tailwind is there’s still reopening opportunities across the board – think about things like cross-border travel as well as the domestic Chinese economy – so lots of reopenings still to come. And then, lastly, the indiscriminate market selling we’ve seen over the last couple of years in pockets of the globe has led to attractive valuation opportunities on a very stock-specific basis as well.
[02:33] James Craige, CFA, Co-Chief Investment Officer, Head of Emerging Markets, Stone Harbor Investment Partners
In fixed income, is EM or DM more compelling?
Emerging markets are the more compelling asset class for three reasons – growth, inflation, and pricing. From growth’s standpoint, we’re currently looking at growth numbers coming out of 2022 that clearly favor the emerging markets. We’re seeing growth of the group at just above 4%, which is outpacing developed market economies by a significant margin. This gets it back to the long-term average. Why? These are still developing economies with lots of growth potential from an emerging middle class. That has not changed. Add attractive FX levels due to the strong dollar and better global demand for emerging exports and you have a solid growth story. Second, inflation. we’ve seen a peak in inflation in emerging markets and expect it to decline significantly in most emerging markets over this year. EM central banks did not have the luxury of believing inflation was transitory. Accordingly, they began hiking a year earlier than the developed markets and much more aggressively. It worked and because of this we expect we’re near the end of the hiking cycle. And, finally, pricing. Rising risk aversion led to significant broad-based spread widening last year, particularly in emerging markets. We’ve seen this before. The yield matters a lot in fixed income total return and we have a lot of it – at 8.5-9% for the market and 12.5-13% for the high yield portion of the market, you’re pricing in a lot more risk than actually exists. Take the yield. Use the volatility to your advantage.
[03:54] John Mowrey, CFA, Chief Investment Officer, NFJ Investment Group
Yes or no to investing in Chinese companies?
So, everybody loves to hate China. We think China is a very interesting asset class and should warrant attention by investors. Why? It’s the second largest economy in the world and it’s simply too big and too vibrant to ignore. Even though there’s a lot of negative rhetoric coming out of Washington and China, that has created a real opportunity for longer-term investors. For example, there’s already a billion users of the internet in China, and that’s more than double how many are using the internet in the U.S. and Europe combined. China’s also moving away from a more industrialized economy to a more consumer-led economy. And it’s not to say that China doesn’t have risks, but risk is always relative to the valuations in what you’re paying, and we think at these levels investors are being compensated for that risk in China.
[04:38] Hyung Kim, CFA, Portfolio Manager, Senior Research Analyst, Kayne Anderson Rudnick
Why invest in EM/international small caps?
I think small cap is a space that investors should have exposure to when investing outside of the U.S. First of all, small cap is a large universe with thousands of companies. In fact, the international and emerging markets small-cap space is much larger than the small-cap space in the U.S., so this gives us a large pool of companies to pick compelling ideas from. Secondly, the small-cap space tends to be much more inefficient, which oftentimes allows us to find very compelling investment opportunities. And many small-cap companies are not actively covered by sales side analysts – the average number of analysts covering individual stocks in EM small cap, for example, is two to three versus ten to fifteen in EM large cap. A big chunk of our portfolio companies are not covered at all or are only covered by one or two local brokers. Small caps also gives investors true emerging markets and international exposure whereas the large-cap international/EM indices have exposure to companies that are really more global in nature, generating large amounts of revenue in the U.S. or in developed markets. Lastly, in small caps, if you can pick the right stock, you have the potential to pick a business at an early stage of the growth cycle and benefit from the growth as a small-cap stock grows to become a mid-cap or even a large-cap stock over time.
[06:11] Lu Yu, CFA, CPIM, Lead Portfolio Manager, Virtus Systematic
How is big data transforming global investing?
We believe big data creates new investment opportunities of all kinds. Data is growing at a faster pace than ever before. Today, 90% of the data was actually created in the last two years, and every two years the size of data doubles its size. And, globally, only 20% of the data are “structured data” – these are the numbers – while 80% of the data are “unstructured data,” including text and images. In the past, quantitative investors could only analyze structured data but today with the new technology, we can now analyze unstructured data as well. So, quantitative investors like us, Virtus Systematic, now we can analyze company transcripts, broker reports, and the news flows to capture new investment themes. So, we believe we’re in the very first or second inning of using big data to generate investment opportunities for our clients and that should create a lot of opportunities down the road.
[07:13] Geoff Dybas, CFA, Senior Portfolio Manager, Head of Real Estate, Duff & Phelps Investment Management
Where are global real estate opportunities now?
Historically, as well as today, we’ve found a wonderful opportunity set in listed real estate going beyond the traditional core property sectors, such as office, such as lodging, and such as regional malls. Those three sectors today represent not even 10 cents on the dollar in listed real estate space. And, so when we look at the opportunity set that is awaiting us, it includes benefits of secular growth trends, including in well-located e-commerce facilities, in logistics, in cell towers, in data centers, as well as recovering opportunity set in senior housing properties, within residential, single-family home rentals, select apartment opportunity sets, as well as student housing. These are all wonderful opportunities for us that we find are strong opportunities from an investment standpoint. Now, on a global basis, which gives us an even broader opportunity set, we can dive into select names in different parts of Asia-Pacific, across the Americas, as well as in Europe, whether on the continent, in the Nordics or in the U.K. And across this global opportunity set, we come away with what we think is a wonderful opportunity that affords us and our investors the allocation benefits of listed real estate.
[08:30] David Souccar, Portfolio Manager and Senior Research Analyst, Vontobel Quality Growth Boutique
Why active management when investing abroad?
We believe that active investors have an advantage versus the international benchmark. While in the U.S., high-margin sectors like IT and health care account for 43% of the market, in international markets they account for less than 20%. Financials, industrials, and commodities – sectors with lower margin and higher cyclicality – contribute to half of the weight in the international benchmark. In fact, the average company in the S&P compounds earnings two times faster than the average international company and with margins that are 400 basis points higher. Having said that, for investors who want to go the extra mile, there are diamonds to be found outside the United States. As an example, companies like Hermès, Constellation Software, and Keyence grow earnings at a faster clip and with higher margins than the S&P 500. We believe that a concentrated portfolio of quality international stocks can deliver alpha and competitive absolute returns for U.S. investors.
The comments are the opinions of the speakers. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice or an offer of securities.
Past performance is no guarantee of future results.
All investments carry a certain degree of risk, including possible loss of principal.
Diversification does not assure a profit or protect against losses.