China is an Example of Why You Need Global Diversification
Key Takeaways
It is logical to correlate high growth to high returns in asset prices. However, such expected returns do not always pan out - with BRICs being a good example.
Many investors tend to alter their investment allocations to try to tap onto new growth areas or revolutionary developments in an effort to achieve higher returns. However, “new” does not mean better returns.
The evidence points to being globally diversified — meaning allocating your investments in a proper and methodical way to represent what the investable world looks like at the moment, as the best way to improve the reliability of your long-term investment outcome.
Diversification Is Your Buddy
— Merton Miller
In 2001, former Goldman Sachs economist Jim O'Neill coined the term “BRIC” which denoted the economies of Brazil, Russia, India and China; countries which were experiencing significant growth. Goldman Sachs believed that these economies would grow to such a large size that they would dwarf the G6 countries in the decades to come. To tap on this catchphrase, the bank launched a slew of investment products targeting these countries with many other managers following suit as demand swelled.
Whilst BRIC (and later on BRICS with the addition of South Africa) was the buzzword in the mid to late 2000s, market returns did not materialise as expected and Goldman Sachs eventually closed the fund with a whimper (chart below). Only a fraction of BRIC funds remain. (As BRIC Fund Assets Collapse, Jim O’Neill Is Keeping Away).
It is logical to correlate high growth to high returns in asset prices. However, the randomness of global stock returns makes it very difficult to figure out which markets are likely to be outperformers. After all, do we really need to target a certain country or sector to tap into the growth of that region?
Globalisation ensures that we enjoy the benefits of an interconnected world everyday. Your cup of coffee that you have in the morning likely originated from South America. If you check your email in the morning on a smartphone, its probably designed in California and manufactured in Taiwan. As you head to work, you could be driving a German-made car or riding in a French-built train to work.
As such, to tap onto the growth of the Chinese consumer or access the demographic tailwinds of Indonesia, you need not specifically invest in Chinese or Indonesian companies. For example, the chart below shows the breakdown of the revenue contribution of different global regions to Apple’s quarterly earnings. Whilst Apple is a US company, listed on the US stock exchange (NASDAQ), it derives less than half of its revenue from the US itself. Large contributions come from other parts of the world.
Coming back to the topic on hand — and why investing in themes or reasonable theses may sometimes not pan out so well.
Everyone knows that China has been struggling recently. Despite being the second largest economy in the world, the stock market performance has not been showing similar strength; underperforming the global stock index over the past 3 years by over 60%.
You could put it down to short-term weakness. But what if you were transported back in time to the mid-90s and you had a magic genie — a genie who told you that China would be one of the fastest growing countries in the world with its economy expanding by 20x?
It would seem perfectly logical to assume and bet on the country’s stock market to grow by a similar amount. It is amazing that China’s GDP rose from $863.7 billion in 1995 to $18 trillion dollars today. Unfortunately, the returns from investing in China did not provide a 20x return (chart below). In fact, Chinese stocks underperformed global stocks during this period by a staggering 472%.
Whilst many investors sometimes seek to alter their investment allocations to try to tap onto new growth areas or ideas in an effort to seek higher returns, not all of these deviations result in higher returns. Very often, it leads to worse outcomes.
As such, the evidence points to being globally diversified as the best way to improve the reliability of your long-term investment outcome. This is the reason why our core portfolios adhere to this philosophy. Being diversified means allocating your investments in a proper and methodical way to represent what the investable world looks like at the moment. Concentrating your assets in a few areas can give you higher returns, but the probability of success is low.
If you want to have a second opinion on whether your investments are diversified in a proper manner, come and have a chat with us.
