Far from being a complex decision, allocating capital between regions and markets is essentially a digital process, driven by the manager’s view of the equity market.
Accounting for about 46 per cent of the world index, US equities dominate returns of the global indices and hence a fund’s exposure to the US market will drive its relative performance against those indices.
As it is almost impossible to hold a mean-ingful overweight position in US equities, without turning into a US equity fund, most global equity managers – including fund of fund managers – typically run portfolios that are in line or, more usually, significantly underweight in this most dominant of markets.
The recent poor relative returns from US equities and the weakness of the dollar have been very supportive for global equity fund managers but future returns are at risk from a reversal of this trend.
Evidence for this view is provided by the last period of relative US strength at the end of the 1990s. Over the period from 1997 to 1999, the average global equity manager, as measured by the IMA global growth sector, underperformed the benchmark FTSE World index by 20 per cent.
This issue is of particular concern as so many of the regions favoured by active managers appear expensive and overbought compared with the US. It is an inherently dangerous time for fund managers, who must decide whether to retain an underweight position in the US or neutralise this position to minimise the damage caused by a resurgent US market.
Whichever approach is adopted – we favour the latter – adding value through asset allocation will become increasingly difficult if market leadership does revert to the US.
To combat this potential problem, we are increasing our use of sector-specific and focus funds while retaining a broad benchmark exposure to Western and especially US equities.
We favour stock-centric managers such as Nick Train at Lindsell Train and Phil Doel at F&C, who run concentrated portfolios which differ radically from the benchmark index.
Elsewhere, exposure to global themes is provided by holdings in technology and other sector-focused funds.
Returns from this approach may look unspectacular if the current market themes continue to stretch further but we firmly believe it is time to look over the hill at the coming market and position ourselves for the future rather than the past.
Dan Kemp is fund of funds manager and head of fund research at Williams De Broe.