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Flexing Your Global Portfolio Can Lead to ACWI Fatigue, but Don't Throw in the Towel Yet

June 6, 2017  | by Mark J.P. Anson

Asset Allocation | Investment Strategy

Like the build-up of lactic acid in your muscles after a strenuous workout, the underperformance of Morgan Stanley Capital International All Country World index (MSCI ACWI) vs. the Standard & Poor’s 500 (S&P 500) – or any U.S. equity benchmark, for that matter – for the last several years has been building up to a painful point. This pain threshold has pushed investors to the limits of their global endurance resulting in what we call “ACWI Fatigue.” ACWI Fatigue is most acute with institutional investors who use the MSCI ACWI as their equity benchmark and, as a result, have a globally-oriented equity portfolio.

Exhibit 1 demonstrates this Fatigue. Since the Great Recession, ACWI has underperformed the S&P 500 in six out of eight years. The natural query that investors make is why construct their portfolios to match a global benchmark when the U.S. stock market performs so much better? The question seems all the more relevant in light of the extended underperformance of ACWI compared to the S&P 500.

Geographical Performance Leadership is Cyclical

However, before we throw out our global training regimen, let’s take a closer look at the longer term track record of ACWI ex-U.S. versus the S&P 500. Exhibit 1 presents a clear cyclical pattern. There are long stretches of time when ACWI ex-U.S. outperforms the U.S. equity markets and vice versa. Trying to time these markets is not an easy task but it is clear that the performance of ACWI ex-U.S. and the S&P 500 do complement one another.

Exhibit 1
EX1-SP500vsACWI

Another part of the Fatigue is the increasing globalization of economic fundamentals. Going back 20 years, economists referred to the “G7”—the seven largest industrialized nations that ruled much of the world’s economic output. Then this group expanded to the G10, then the G15 and, today, the G20. Simply put, the world has become a smaller place. Macroeconomic policies—both fiscal and monetary—are synchronized to a much greater extent than they were just 10 years ago. This means that diversification on a global scale has less of an impact today than in the past.

Global Correlations are Up – But That Might Not Tell the Whole Story

Exhibit 2 demonstrates this point. We chart the rolling correlation of ACWI with the S&P 500. Exhibit 2 indicates that going back to the early and mid-1990s, the correlation between ACWI and the S&P 500 was about 0.5. However over the last 15 years, this correlation has climbed to 0.95.

Another reason for this increased correlation across global equity markets is that corporations now sell to the global market place. Coca-Cola earns the majority of its revenue from outside the United States. Mercedes, Audi, and BMW sell more cars in the United States than in Germany. Large corporations now operate on a multinational scale—geographic borders do not define the limits of their marketplace.

Exhibit 2
EX2-3YRCorrACWI+S&P

Yet, despite this increased synchronization across economic borders there are still benefits with respect to a global equity benchmark. First, modern portfolio theory teaches us that the more you constrain your portfolio, the less efficient it becomes. Simply, you shrink your economic sandbox by committing to a domestic equity benchmark. Conversely, committing to a global benchmark like ACWI does not mean that you must follow the precise geographic weights contained within the global benchmark (roughly 55% U.S., 30% Development Markets ex-U.S., and 15% Emerging Markets). Instead, an investor can still retain the freedom to overweight the U.S. relative to international markets, while maintaining the largest sandbox available.

An Expanded Global Opportunity Set is Still Good Investment Practice

Think back to our example of Mercedes, Audi and BMW selling more cars in the U.S. than in Germany. If a U.S. investor were to limit his or her portfolio construction to only the U.S. equity market, there are only three independent car manufacturers remaining in the United States: Tesla, Ford and General Motors. That is a very limited bet on the auto industry. Conversely, outside the U.S., the auto industry is much larger—from Mercedes to Toyota to Hyundai. The larger the sandbox, the more cars you can play with in it. Further, if you commit only to the U.S., you only access about one third of Global GDP Growth, as seen in Exhibit 3. Even if correlations remain high, gaining access to other economic drivers of global GDP is a sensible (and economic) thing to do.

Exhibit 3
EX3-GDPGrowth

Lastly, this larger sandbox is even more important for institutions that choose to use active management for all or significant portions of their equity allocations. In the quest for alpha, we have found that providing active managers the freedom to search out and act on their best ideas globally is an important contributor to long-term performance success. This is all the more important in less efficient markets, like emerging markets that are a significant growth engine for global GDP, as well as for developed markets like Japan that might follow different fiscal & monetary policies than the United States.

This article was originally published in Pensions&Investments on June 2, 2017

Authors

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Mark Anson is the Chief Executive Officer and Chief Investment Officer of the Commonfund and Chairman of the Board of Commonfund Capital Inc. and Commonfund Asset Management Company. Previously, he was the President and Chief Investment Officer for the Bass Family Office of Ft. Worth, Texas which was recognized as Family Office of the Year for 2014 & 2015. He was the President & CEO of Nuveen Investments, and Nuveen Alternative Investments, a full service asset management company with over $250 billion in assets under management. Prior to Nuveen, Mark served as the Chief Executive Officer and Chief Investment Officer for the British Telecom Pension Scheme (BTPS), the largest institutional investor in the UK with assets of £65 billion. In addition, Mark was the CEO of Hermes Pensions Management in London, a £55 billion asset management company that is wholly owned by the BTPS. Prior to joining BTPS, he served as the Chief Investment Officer of the California Public Employees' Retirement System, the largest institutional investor in the United States with over $300 billion in assets. Mark is currently a Trustee for the $65 billion UAW Medical Benefits Trust. He also serves on the Law Board of the Northwestern University School of Law, the Board of the Toigo Foundation, and the Board of Panagora Asset Management. He is the only person to have served on the Board of Governors for both the CFA Institute and the CAIA Association.

Mark has published over 100 investment articles in professional journals and has won three Best Paper Awards. He is also the author of five financial textbooks including the Handbook of Alternative Assets, which is the primary textbook used for the Chartered Alternative Investment Analyst program. Mark earned a B.A. in Economics and Chemistry from St. Olaf College, a Ph.D. and Masters in Finance from Columbia University Graduate School of Business, and a J.D. from Northwestern University School of Law, all with honors. He has also received several industry awards in recognition of his leadership in asset management. Last, Mark has earned the Chartered Financial Analyst, Chartered Alternative Investment Analyst, Certified Public Accountant, and Chartered Global Management Accountant professional degrees, and he is a Member of the Law Bar of New York and Illinois.

Mark Anson, PhD, CFA, CAIA
Chief Executive Officer and Chief Investment Officer

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Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.