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You complete me: The case for international sector exposure
BY JOHN DYALL | MONDAY, 30 OCT 2017   3:07PM

Over three years the Colonial First State Global Health & Biotechnology Fund was the top performer in the international equities space, returning 20.1% pa after fees to August 2017. Over five years the returns have been even greater - 26.4% pa.

Compared with its international equities benchmark (MSCI World) it outperformed around 28% (in absolute terms) over three years and 87% over five years. It's even outperformed the MSCI All Countries Healthcare Index quite significantly.

The product - which is sub-advised by global investment firm Wellington Management Company out of Boston - is an interesting case study on what constitutes an international equities fund and whether funds focusing on specific sectors deserve a place in investment portfolios.

My argument is they are deserving, they just don't go far enough. The basic argument is that the Australian share market is heavily skewed to certain sectors, namely financials (37% in Australia versus 18% worldwide) and materials (16% in Australia versus 5% worldwide). And if we are skewed to sectors we must also be skewed away from other sectors, like information technology (17% global versus 1.4% Australia) and health care (12% global versus 8% in Australia).

So, there are three logical reasons why investing in a fund such as this makes good investment sense.

Firstly, investing in an industry that is underrepresented locally gives the investor real diversification in their equities portfolios. Stocks within an industry behave more alike than stocks that are in different industries. Also, while there are diversification benefits to be had by investing in different countries, there is just as much if not more benefit from investing in different industries.

Secondly, it opens up the universe of investment opportunities. With ageing demographics in the developed world, the healthcare and biotechnology sector has a tail-wind in terms of growth opportunities that may not exist in other sectors. In particular, biotechnology is going through a revolution as profound as anything happening in technology.

Thirdly, investing in a fund like this still provides investors with market exposure, although with some specific risks. In the past three years the fund has had a beta of around 1.2 (which means the product is effectively geared to international equities returns without the need to be geared), high tracking error of around 12% pa (the typical actively managed international equities fund has a tracking error of around 4%) and higher volatility than the benchmark (17% pa versus 11% pa).

Clearly many people do not agree with this assessment. The fund has only $6 million in it, but that doesn't mean it's a bad idea. Perhaps it doesn't go far enough (not this fund specifically but international funds with a sector bias).

I said earlier that fund managers haven't gone far enough with this sector-specific product development. The Australian share market has one major advantage over international shares and one disadvantage. The advantage is franking credits. International shares don't give them and they are worth a lot to Australian investors. The disadvantage is lack of industry diversification.

A product that has a core of Australian shares and a completion element of international sectors (heavy on information technology, health care, consumer discretionary, light on financials, materials and REITs) would provide both franking credits and industry diversification. They could even call it the "You Complete Me" Fund.

1 comment so far
  Nice article John - and it makes absolute sense. Particularly for investors with a reasonably aggressive risk profile. Good to see you are clearly revelling in your Rainmaker role.
CHRISTOPHER GUNNS  |  31 OCT 2017   12.29PM
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