Active global equity funds have become a cornerstone of many portfolios as investors have switched from regional allocations. Offering the prospect of diversification and alpha generation, global active equities help investors reduce potential home bias, and access opportunities from the broadest universe of companies.
However, we see the risk of a new bias emerging within these products: a potential trend towards growth style and technology stock bias. Clustering around certain factors or sectors not only reduces the intended diversification benefits of multi-manager portfolios, but also raises concerns about potential overexposure to a narrow segment of the market that may be nearing its peak.
Below, we explore the limitations of traditional diversification strategies and highlight the unique advantages of the Redwheel Global Intrinsic Value strategy in addressing this critical issue.
Evidence of bias and its impact
A key metric for evaluating diversification is the correlation of relative performance between funds against a particular benchmark. Our analysis [1] reveals a surprisingly high correlation (0.15-0.75, average 0.5) among the relative performance of five of the most recognised active global equity strategies in the world [2] against the MSCI World index.
This significantly higher than expected correlation indicates a lack of independent stock selection and reinforces the observed bias towards growth and tech themes. There could be multiple possible explanations as to why this phenomenon exists among this group of active strategies. Narrow leadership of equity markets have arguably contributed to it [3]. The clients’ dissatisfaction with the underperformance of more diversified active managers and shift of assets to this more successful group of managers likely contribute to it as well. Finally, having missed some of the growth style and Magnificent 7 [4] wagon, some active fund managers capitulated and joined what many investors regard as the only success story in the equity markets.
But being able to explain and justify the development is of little help in solving the issue. In essence, many of these popular active funds are playing the same game, undermining the diversification rationale behind multi-manager portfolio construction. Investors are unknowingly losing the very benefit they sought – exposure to a variety of uncorrelated investment strategies.
The diversification dilemma
The most straightforward approach to address this potential bias would be to introduce assets with low correlation to the existing portfolio. Value investing, by its very nature, presents the opposite end of the investment spectrum compared to growth. A value-oriented allocation offers the potential to dampen the portfolio’s absolute and relative volatility and enhance returns through exposure to a potentially undervalued segment of the market.
Challenges of traditional value investing
Despite the compelling diversification argument in favour of value investing, there are significant headwinds to consider. During periods of strong growth leadership, as we are currently experiencing, many investors perceive a significant opportunity cost associated with allocating to value stocks. The fear of missing out on hot growth stocks can be a powerful psychological barrier. Additionally, accurately timing a market shift from growth to value presents a significant challenge. Investors who attempt to time the market often end up chasing past returns, potentially missing out on value opportunities altogether.
Our solution: Global Intrinsic Value strategy
Given the limitations of traditional value investing in the current market environment, we propose our firm’s Global Intrinsic Value strategy as a compelling alternative. This strategy goes beyond traditional value investing by offering a deeper and more pronounced value bias compared to passive value indices or other value-oriented active managers. Our approach focuses on identifying companies with a significant disconnect between their intrinsic value and current market price.
Benefits of our Global Intrinsic Value strategy
We believe our strategy provides several advantages that directly address the challenges of traditional diversification and value investing:
- Enhanced diversification with reduced growth exposure: The deeper value tilt allows for greater allocation to existing growth managers within a multi-manager portfolio while still achieving meaningful diversification (as each dollar invested in this strategy is likely to bring more “value” than most alternatives). Investors can benefit from the potential upside of growth stocks while mitigating downside risk through exposure to undervalued companies with strong recovery potential.
- Reduced timing risk: The intrinsic value focus offers a compelling investment thesis regardless of immediate market leadership. Our strategy prioritises companies with a strong foundation of inherent value and long-term growth potential, providing resilience in any market environment. By focusing on intrinsic value, we are less concerned with short-term market gyrations and more interested in capturing long-term opportunities.
- Durability and recovery potential: Our portfolio prioritises companies with a solid track record, strong management teams, and sustainable business models. These characteristics position our holdings for long-term durability and robust recovery potential, even in challenging economic environments.
- Potential for outperformance: The current undervaluation of value stocks creates the possibility of strong performance, regardless of a near-term market shift. As the market recognises the inherent value of our holdings, we anticipate significant upside potential for investors.
Diversification through deeper value exposure
The pronounced growth bias within active global equity funds poses a significant diversification challenge for investors. Our analysis suggests that a well-constructed value strategy can be a powerful tool for addressing this challenge. We believe our Global Intrinsic Value strategy offers a compelling solution by providing deeper value exposure, reduced timing risk, and the potential for enhanced returns. This strategy can be a valuable tool for investors seeking to navigate the current market environment and achieve true diversification within their multi-manager portfolios.
Sources:
[1] From 1 December, 2017, the ‘common inception’ date[1], until 31 May, 2024. Common inception is the date of the most recently incepted fund within a group of selected funds.
[2] Funds include Fundsmith Equity, Brown Advisory Global Leaders, Lindsell Train Global Equity, GuardCap Global Equity and MS INVF Global Brands Z. These funds are the among the largest and most recognised active global equity strategies in the world.
[3] Source: Bloomberg, as of 8 July.
[4] Microsoft, Amazon, Alphabet, Tesla, Meta Platforms, NVIDIA and Apple.
Key Information
No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment. Past performance is not a guide to future results. The prices of investments and income from them may fall as well as rise and an investor’s investment is subject to potential loss, in whole or in part. Forecasts and estimates are based upon subjective assumptions about circumstances and events that may not yet have taken place and may never do so. The statements and opinions expressed in this article are those of the author as of the date of publication, and do not necessarily represent the view of Redwheel. This article does not constitute investment advice and the information shown is for illustrative purposes only.
