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A global approach is key to higher returns

Photo of Karl Siegling, Cadence Capital By Karl Siegling, Cadence Capital

min read

Cadence's top picks to benefit from a falling dollar and falling interest rates.

Investors have seen the Australian dollar move, over a decade, from around 60 cents against the US dollar to $1.10 and back to 78 cents. We hope it does not go lower.

Over that time the iron ore price has moved from around US$30 to US$190 a tonne and back to US$47. It is to be hoped that iron ore does not go lower, especially if we own iron ore stocks.

In a decade the oil price has risen from $40 a barrel to $140 and back to $45. Again, we hope the price does not fall further, especially if we own oil or energy stocks.

The three most dangerous emotions for investing are hope, fear and greed. This means our hopes for the Australian dollar and iron ore and oil prices, while based on "wishful thinking", should not influence investment decisions. Investments based on hope alone most often prove to be poor choices.

The fact is, the Australian dollar, the iron ore price and the oil price are currently in downward trends.

Conversely, we are living in a period of falling interest rates. In fact, they have been falling for nearly 30 years and all indications from the Reserve Bank of Australia are that they are set to fall further. Lower rates send the price of interest-rate-sensitive assets, such as banks and real estate investment trusts, and stocks, higher.

In some cases we have seen a trend for rate-sensitive assets and stocks going higher and higher over nearly three decades. Most investors can point to the stellar run of Australian residential and commercial property. Similarly, everyone is aware of the longer-term trends for banking and diversified financial services stocks.

These trends look to be continuing, although many commentators and investors alike point to the lofty relative valuations of these assets and stocks, especially when comparing valuations for them against periods of higher interest rates.

A restricted investing universe

Where does that leave trend investors and those who wish to continue investing following current trends?

Put simply, those investing with the trend (buying rise stocks, and selling falling ones), rather than trying to fight the market, find themselves in a substantially restricted investing universe.

That universe is: Do not invest in commodities and resources stocks that continue to experience downward trends. Do not invest in oil and energy stocks that continue in a downward trend. Do not invest in assets that fall in value with falling interest rates. Do not invest in assets that fall with a falling Australian dollar.

Conversely, invest in assets that rise with falling interest rates and invest in assets that rise with a falling Australian dollar.

As always, as bottom-up investors, Cadence is not forming a view and analysing the overall market, but rather investing in particular stocks, in particular sectors of the market that are displaying strong bottom-up fundamental characteristics, while displaying strong price trends.

It should come as no surprise that those sectors and stocks in the market that show the strongest fundamental characteristics also tend, over time, to display the strongest trends.

Those sectors at the moment are: domestic banking, domestic diversified financial services, the overseas banking sector and overseas diversified financial services, as well as selective industrial, consumer and technology companies, both domestic and overseas.

How to profit from these trends

Followers of Cadence's monthly newsletters and portfolio would observe that these trends have been established for some time now and we continue to add to existing positions and find selective new positions within these sectors.

(Editor's note: Do not read the following ideas as stock recommendations. Do further research of your own or talk to a financial adviser before acting on themes in this article).

Top positions within the portfolio are Macquarie Group, Luxottica Group SPA, Henderson Group Plc, Bank of Queensland, Retail Food Group, the four major Australian banks, Mastercard Inc, Visa Inc, and a number of positions in US biotech/pharma companies such as Gilead Sciences Inc and Mallinckrodt Plc.

Macquarie has approximately 65 per cent of earnings derived from outside Australia and Henderson around 95 per cent. Luxottica is a truly global sunglasses manufacturer, distributor and retailer.

Bank of Queensland and the four Australian major banks continue to benefit from falling Australian interest rates and rising residential and commercial property prices. Overseas banks and diversified financial services continue to benefit from falling global interest rates and rising property prices.

In addition, the overseas positions in our portfolio have benefited from a rise in the US dollar and corresponding fall in the Australian dollar.

Overseas equities have outperformed

Global equities have outperformed Australian equities in our portfolio over the past year. For observers of global equities indices, this should come as no surprise because global indices have outperformed domestic indices in the past year as well. For reasons outlined above, these trends look set to continue.

Therefore, the process of adding to winning positions and investing in new positions in stocks showing strong fundamentals in sectors that are performing well will inevitably mean a larger portion of our portfolio will be invested in overseas stocks in the year ahead and foreseeable future.

Our investment process is highlighting that Australian investors would be well served investing portions of their equity investment portfolio into global equities. Of course, no trend or investment thesis lasts forever and a company with strong fundamentals now may not have strong fundamentals a decade from now.

Similarly, companies with poor fundamental characteristics now may experience stronger fundamentals a decade from now. This is particularly true for the resources portion of the Australian economy, which experiences long and protracted cycles of boom and bust.

Historically there has been some reluctance to invest globally, because overseas equities are perceived as riskier than domestic investments. Ironically, it may be that in more recent history, and especially in the resources boom and subsequent bust, the Australian market has in fact been a relatively riskier place to make equity investments compared to many global markets.

Australian investors are facing a new imperative to invest offshore as the size of the superannuation asset base in Australia approaches $2 trillion and is predicted to reach $3 trillion in the next seven years.

To put this in context, the entire market capitalisation of the Australian sharemarket is around $1.7 trillion. There simply is not a large enough investable universe for us to invest in. This factor alone has the potential to inflate valuations of Australian share investments, which in turn should be alerting investors to start investing a portion of their equity portfolio offshore.

About the author

Karl Siegling is a portfolio manager at Cadence Capital (ASX: CDM). To learn more about Cadence Capital, sign up for its monthly newsletter.

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