CONNECTING ASIA TO YOUR AUSTRALIAN EQUITY STRATEGY

We believe that Asian equity alpha and beta can be a great complement to Australian equity portfolios. This is because it can mitigate some of the concentration risk and franking risk of the Australian equity index. It can also provide higher alpha potential than an Australian-only equity portfolio.

If you haven’t observed Asia for some time, you will notice some apparent changes. Asian beta is interesting as it provides greater diversification across countries and sectors, and more idiosyncratic risk. It provides access to growth at better prices and its correlations with Australia are moderate to low. It also provides the ability to play many of the big themes in the market, such as technology.

We believe strong alpha returns are still available across Asia using a quant model that combines momentum and value factors – and we believe that these returns have the potential to be even stronger when joined with a view on fundamentals. In fact, our research shows us that an Asia (ex Japan) model has a much higher success rate (or information co-efficient) and expected returns when compared to models in developed markets.

We also believe investors could increase their Asia ex-Japan weightings over time to be more reflective of the gross domestic product (GDP) share of the emerging Asian nations, and the strong growth characteristics and return potential of these markets. There are a variety of ways investors can access these markets and returns. One approach is to free up a small portion of their existing Australian equity portfolio and allow their portfolio manager to invest in some selected Asian stocks, or separately allocate to a pure Asian fund. For investors who do not want the beta risk of Asia, invest in an absolute return product or invest in a traditional long-only Australian mandate.

insightpaper

CONNECTING YOUR EQUITY STRATEGY TO THE REAL WORLD

IN THIS PAPER WE DISCUSS...

− How Asian equity alpha and beta can mitigate risk and provide higher alpha potential when combined with an Australian equity portfolio.

− Why US REITs are a smart choice for investors looking for stable dividends with less long-term volatility than the overall share market.

− How thematic investing works and the reasons why it is effective in delivering total return outcomes.

LACHLAN DAVISHead of Active Quant Funds

Our recent Global Equity Forum took place in Australia in April 2015. The purpose of the forum was to share work from our research program with institutional clients and consultants. It was also an opportunity to hear about some of the challenges facing investors, and to allow us to consider these in the management of opportunities and risks in client portfolios.The topics we showcased were all around the theme of reconnecting your equity strategy to the real world. These included insights from our global equities and real assets teams on opportunities available in Asian equity markets and yield aware listed real assets. We also covered how top-down growth outcomes, and bottom-up outcomes, can be combined in a total return solution through global equities.

Information co-efficients are typically linked to:

> Level of market maturity

> Efficiency of market

> Split between retail and institutional investors

MAY 2015

IMPROVING PORTFOLIO OUTCOMES WITH YIELD AWARE LISTED REAL ASSETS

A question we hear from many investors is: “Where can I invest if I’m looking for stable dividends with less long-term volatility than the overall share market?” We believe that in the world of global equities, real estate investment trusts (REITs), in particular US REITs, are a natural place to look for income.

Relative to fixed income, REIT yields are in line with long-term averages, and relative to US equities they have consistently met or beat earning expectations.

Historically, REITs have also provided stable dividends. Currently, forward dividends are supported by a cycle low in payout ratios which can’t fall below minimum levels to maintain REIT tax status. This will help dividend yields move from 3.4% towards 4% over the next few years.

Fund flows have been strong for the past 15 years, driven by investors’ demand for yield and the asset class’ healthy relative and absolute returns. Ongoing strong inflows are expected to be driven by demographic trends and the continued maturity of the asset class. Also, REITs are about to be given their own Global Industry Classification Standard (GICS), which is expected to have a long-term positive effect on fund flows. With regards to risks, we believe that rising rates may be a short-term catalyst, but should not lead to any significant underperformance. Property in the medium-term and current valuations in both suggest REITs are a relatively attractive way to access property fundamentals, as there is a long queue of investors in the market for direct property.

US REITs versus fixed income yields

Source: UBS, Green Street Advisors, AMP Capital.

MATTHEW HOULTHead of Global Listed Real Estate

BOB THOMASCo-head North American Listed Real Estate

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

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US REITs vs Fixed Income Yields

US REIT Implied Cap Rates US 10-Yr US Baa Corp Bonds

ADDING MEGA TRENDS TO YOUR EQUITY INVESTMENT STRATEGY

ALIGNING YOUR INVESTMENTS WITH THE LONGER-TERM TREND

The major benefit of thematic investing is rooted in human psychology and behavioural finance. As people generally underestimate long-term impacts and overestimate short-term impacts on asset prices and economies, the market tends to undervalue secular growth. We believe that using thematic investing as part of a top-down framework can be a superior alternative to only assessing traditional macro-data – which is typically high-frequency, volatile and can result in overtrading. In essence, thematic investing is about aligning with the longer-term trend rather than speculating on the deviations around that trend.

RANKING STOCKS BY THEIR EXPOSURE TO SECULAR INVESTMENT DRIVERS

We also believe thematic investing is a superior alternative to using a benchmark. In a world that is rapidly becoming more global, and where technology is breaking down traditional barriers, the size of a company or its place of listing in an index has no bearing on the long-term fundamentals of the company. We’ve found that ranking stocks by their exposure to secular investment drivers is a more effective way to deliver an improved outcome over time.

BOTTOM-UP FUNDAMENTALS ARE JUST AS IMPORTANT WHEN INVESTING THEMATICALLY

While thematic investing has many benefits, most clients tell us they don’t know how to build a portfolio around it. Some clients have had mixed experiences with thematic managers or thematic exchange traded funds, where thematic investing has been misapplied. There is a simple answer to this – bottom-up fundamentals are just as important, if not more so, when investing thematically. Finding growth is good, but it is even more crucial to find quality companies and management teams that use that growth opportunity wisely and create additional value through sustainable return on capital and return of capital. We believe that by using a combination strategy, portfolios tend to suffer less during corrections and bear markets, reducing the risk of permanent capital loss, whilst they also tend to rebound much sooner.

THEMATIC INVESTING IS NOT A NEW ‘FAD’

Like many themes in finance, there is nothing new with thematic investing - apart from its label and the way it is applied. Indeed, teams who are well accustomed to managing long duration assets such as infrastructure and property have been analysing secular trends and their impact on client portfolios for nearly 30 years. In addition, those who are experienced in managing environmental, social and governance investments will also be attuned to managing portfolios for long-term themes.

ANDY GARDNERPortfolio Manager

Important notice: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

© Copyright 2014 AMP Capital Investors Limited. All rights reserved.

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