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Greetings!
If you missed my last e-Newsletter, I am pleased to announce an exciting new feature of my website: the professional profiles of my Board of Advisors. Each of these brilliant, talented and deeply experienced individuals brings a specific strength to Reynolds Group, Private Investment Counselors™. It is my privilege to have these individuals on my team and I encourage you to read their profiles.
This week's e-Newsletter expands upon what may be a new concept - that of Opportunity Classes. Opportunity Classes help you structure your investment strategy based on risk and opportunity, rather than exclusively by security type. There are five Opportunity Classes:- asset allocation (read more),
- super regional allocations,
- manager structure and selection,
- the use of leverage, and
- currency.
Today, I will be discussing Super Regional Allocations. The three remaining Opportunity Classes will be discussed in the weeks ahead. Please use this link to browse prior e-Newsletters.
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 Opportunity Classes: Super Regional Allocations
| Super Regional Allocations relate broadly to geography and economic evolution. Geographically, investors generally look at three Super Regions: the Americas, Europe/Middle East/Africa and Asia. Within each of these Super Regions investors differentiate their allocations between developed economies and emerging economies. Super Regional Allocations also cross traditional security type boundaries. That is to say, Super Regional Allocations may be expressed in a variety of security types, e.g., cash, fixed income (or debt securities), marketable equities, and various alternative assets (e.g., hedge funds, buyouts, and natural resources).
As you might have guessed, currency plays a major role in influencing your Super Regional Allocation. For the time being, suffice it to say that it is essential to establish a currency management philosophy and approach if you decide to invest outside your home currency environment. The complexities of currency and its impact on your Super Regional Allocation will be discussed in the weeks ahead. Today, I will focus exclusively on intended asset exposures. As with my last e-Newsletter, I ask you to suspend disbelief; and I think that you will find this approach quite helpful in developing your investment strategy. |
Six Ways to Think about Super Regional Allocations:
| 1. Home Country or Regional Approach
Investors traditionally invest most of their assets in their home country or region. As their investment thinking matures, investors begin to consider international investments, and typically 'stick their toe-in-the-water' by starting with a small investment outside their home country or region. The problem with this approach is that it completely ignores the market capitalization of the home region as compared to the rest of the world, and it disregards the home region's share of the world's Gross National Product. Let me suggest two other solutions and a few sensitivities to consider.
2. Market Capitalization Sensitive Approach
Unlike a home country or regional approach, a market capitalization approach focuses on global markets. The market capitalization of the globe is simply the total market value of all the marketable securities in the world. The global market capitalization of investment securities is typically divided into two pots: marketable equity securities and marketable fixed income securities. It might not surprise you to know that the bulk of the world's market capitalization is represented by the developed economies of the three Super Regions: North America (the U.S. and Canada), developed Europe (e.g., U.K., Germany, and France) and developed Asia (e.g., Japan, Australia, and Singapore).
For most home biased investors, developing an asset allocation strategy that reflects a global market capitalization calls for a significant adjustment. For these investors, adopting a Super Regional Allocation approach driven by global market capitalization will help them achieve a great deal more global diversification than if they simply stick their toe in the water. This approach may also be appealing to investors who wish to limit their exposure to emerging economies since all three Super Regions' market capitalizations are dominated by developed economies.
3. Gross National Product Approach
A third way to think about Super Regional Allocations is in terms of each region's share of the global Gross National Product (or GNP). Using GNP to drive Super Regional Allocations can be an awakening to some home biased investors, since it will likely increase their exposure to emerging economies as well as increasing the global diversification of their portfolio. This is because emerging countries have a larger share of global GNP than of global market capitalization; and their share of global GNP is growing.
There are a couple of reasons why emerging economies have a greater share of global GNP than of global market capitalization. First, companies in emerging economies tend to remain private. Second, in a pretty amazing turn of events over the last two decades, emerging economies have on balance become creditor nations, while developed economies have become debtor nations. As a result, the developed/debtor nations' share of the global market capitalization of fixed income has tended to grow and correspondingly, the emerging/creditor nations' share of global GNP has also grown over time.
To compound matters, the impact of emerging economies on global GNP is inconsistent across the three Super Regions. Emerging economies in Asia (e.g., China, Taiwan, Korea and India) have a disproportionately larger share of their region's GNP compared to the emerging economies in Europe (e.g., Russia, the Middle East and Africa), which have a much smaller share of their region's GNP. The GNP of the emerging economies in the Americas (e.g., Brazil and Mexico) as a percentage of their region's GNP lies somewhere in between Asia and Europe. Therefore, it stands to reason that an investor whose Super Regional Allocations are driven by global GNP will find that they have a large and growing allocation to emerging economies, especially in Asia.
Investors who can tolerate moving from a home biased approach to a Super Regional approach driven largely by GNP weights will achieve the greatest diversification and the broadest participation in the global economy. Two caveats: 1) do not ignore currency management, and 2) manage your allocation to emerging economies vs. developed economies to ensure that you are not exposing your portfolio to emerging economies at a level that is beyond your comfort zone (see below).
4. Developed vs. Emerging Economies Approach
In thinking about Super Regional Allocations, investors should consider differentiating their allocations between developed economies vs. emerging economies across Asia, Europe and the Americas. Historically, the investment returns from emerging economies have been more volatile than the returns from developed economies. While many investors are comfortable with upside return volatility, they are often less able to stomach the downside return volatility of emerging economies. Each investor should engage in careful emotional introspection when deciding upon their global allocation to emerging economies so they can sleep at night.
5. Some Emerging Markets Are More Equal Than Others
The collection of emerging markets is not an undifferentiated basket of economies. At the top of the 'food chain' are the BRICS (Brazil, Russia, India, China and South Africa - though not necessarily in that order). They are the largest and amongst the most highly developed markets of the emerging world. Though it would louse up a catchy acronym, we might also add Taiwan, Korea and a couple of others to this group.
At the bottom of the food chain are countries that do not yet qualify for emerging market status. These countries are called 'frontier markets.' If you are considering investing in an emerging markets product, then you should find out whether it includes frontier markets - for you could get a surprise either way. For example, do not assume that an investment product that carries the label 'emerging' covers all countries that are not highly developed. The investment product you are considering may exclude frontier markets, which are not a part of the Morgan Stanley Capital International (MSCI) Emerging Markets Index. Further, some emerging investment products exclude frontier markets from their performance benchmark even though the manager may be permitted to use them to a limited degree. If you want exposure to frontier markets, then you should consider making a modest investment in a mutual fund that is dedicated to these areas.
6. It Is a Dynamic World
Just as global economies change, your allocations among the three Super Regions are likely to shift over time. This is regardless of whether you are looking at global market capitalization or global GNP. You should review your portfolio's actual exposures vs. your desired targets quarterly, and rebalance your portfolio toward your targets either quarterly, semiannually or annually. You may also want to reevaluate your target exposures against your global benchmarks (such as market capitalization or GNP weights) on a similar cycle to be sure that you are still happy with your targets (as well as your actual exposures).
You should be aware that Morgan Stanley Capital International (MSCI) periodically reviews its characterization of economies as developed, emerging and frontier. There is a fascinating question about what MSCI is going to do about the BRICS and when. That is, which of them will be graduated to developed status and when? Could MSCI move either China or Taiwan from emerging to developed status without moving both? If Taiwan and/or China were to graduate to developed status then what about Korea, or vice versa? Last year MSCI brilliantly dodged the bullet by graduating just one country from emerging to developed status, and that was Israel. That avoided a lot of controversy. |
| Summary | In developing your Super Regional Allocation strategy, you will want to consider the degree to which you are motivated by home country/region bias. If you are considering diversifying your portfolio globally, then you should evaluate both global market capitalization and global GNP weights across the three Super Regions and determine which set of target weights you are most comfortable with to guide your global investment decisions over time.
Be sure to review the balance that you want to achieve between developed economies vs. emerging economies, and whether you have the stomach for frontier markets.
As a final note, it may also be helpful to overlay your Super Regional Allocation across the six Asset Allocation categories discussed in my prior e-Newsletter on Opportunity Classes.
If this sounds subtle, you may want to work with an adviser or Private Investment Counselor in crafting an investment strategy and implementation plan that will meet your specific and customized needs. You need not leap from where your portfolio is today to where you may want to go over time. If you establish the direction in which you want to go, and if you set a benchmark allocation that you want to achieve, then you can more readily track your progress toward your goals.
I have proposed a new way to think about your asset investment strategy, specifically Opportunity Classes: Super Regional Allocations. I hope that my approach is helpful to you as you make your investment decisions. I am eager to receive your feedback and Letters to the Editor. Please let me know what you agree/disagree with, as well as your priorities for establishing Super Regional Allocations. Click here to shoot me a note, and with your permission I will publish your Letter to the Editor. |
About Us
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Reynolds Group, Private Investment Counselors, LLC helps high net worth individuals, families, private foundations and charitable trusts enhance risk adjusted investment returns, drive operational efficiencies and optimize advisor effectiveness.
email
Jack at RGPIC dot com
617.945.5157
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