Where to invest internationally

Given: (1) a spike in the AUD to 80c vs the USD (2) an increase in the interest in our international fund and (3) that our tactical asset allocation portfolios remain heavily overweight international, I thought it worth expanding on our international equities portfolio and its exposures.

It’s a tough time to be making investment decisions. Everywhere we look markets are expensive, returns look low and risks are building. So, for the most part putting together our international portfolio it has been about finding novel ways to get the exposure that we want.

Country Allocation

Based on growth and relative valuations, we are country agnostic at this point, if the USD keeps falling we will be looking to pick up more US stocks  – that is the market where the growth remains the highest.

While “technically” we are underweight the US, this is illusionary. I’m going to do some work over the next few weeks to illustrate this. Basically, we are finding stocks listed in the US to be relatively expensive and so we have been looking to other markets to find stocks that are exposed to the US at a cheaper price.

For example Unilever is a UK listed stock but Unilever’s actual sales exposure to the UK is only a little over 5% – its biggest markets are actually the US and China.

We have been hunting for value in non-Euro European markets in particular.

The UK is one of the cheapest markets, burdened by Brexit fears, but we are also finding a number of quality multinationals in markets like Finland or Denmark that look better value than similar stocks listed in the US. We are mainly looking for multinationals rather than domestic stocks.

Some of the names include Unilever (household products), Imperial Brands (tobacco), Kone (Finland listed elevator manufacturer), Roche (Switzerland listed healthcare company) and Vestas Wind (Denmark listed but mainly US sales of wind turbines and parts). Most of these stocks have significant US sales, and trade at lower multiples than equivalent stocks in the US.

Industry Allocation

Defensives are expensive. REITs, Utilities, Telcos and Infrastructure are the usual places to look for defensive exposure but (just as the central banks intend) lower risk investors continue to “shuffle up the risk spectrum” and they have bid the price of traditional defensive sectors to levels that make investment difficult.

So, again we have positioned the portfolio to benefit in a different way. We are looking for a mix of the more stable industrial, consumer staples and healthcare stocks to get a similar defensive exposure without having to pay the nosebleed prices in the traditional defensive portfolios.

Our biggest call is underweight energy. In particular oil producers. We have blogged a lot about the oil price, (see this post in particular https://www.macrobusiness.com.au/2017/03/when-will-electric-cars-disrupt-oil/) but the thumbnail sketch of the sector is that:

  • the short term is not positive for the sector with oversupply and OPEC needing to cut production to try to prop up the oil price.
  • the long term is not positive with increasing electrification of cars and falling battery prices limiting the upside
  • the mid-term might be good, if an undersupply emerges and before electric cars put a dent in oil demand and assuming US shale costs don’t keep falling

Meanwhile oil stocks are pricing $60-$70 oil prices in perpetuity – a 20-40% increase on current prices. The mid-term is going to have to be spectacular to justify current share prices, let alone getting any share price growth.

Having said that, it is a big risk to our portfolio being underweight energy. If there are geo-political ructions, particularly in the Middle East, we would probably underperform.

We are underweight financials – mainly as we can’t find US financials that are cheap enough to justify purchasing. We have been trawling the European banks for value.

We have a reasonable tech / IT exposure. Apple isn’t too expensive (although there are growth concerns) and Google we can just squeeze into our model as very high quality but expensive. There are a number of smaller tech stocks that we own, in particular a range of semiconductor stocks where we like the growth outlook.

Investment Exposures

As a reminder, we like to look at stocks on a Quality / Value Matrix – trying to buy stocks below the green line and sell stocks above the red line:

Quality Value matrix for Nucleus investment universe

From a value and quality perspective, something usually has to give – you can’t find great growth companies with stable earnings that are cheap on every metric.

Value Exposures

For the Value axis, we use a broad range of factors including:

  • Cashflow: Free cashflow, Operating Cashflow
  • Earnings: Range of earnings measures, pre and post abnormals, EV/EBIT, P/E
  • Balance Sheet: Asset backing, replacement value
  • Returns: Dividends, sustainable dividends, buy backs, capital returns

At the moment our international portfolio is expensive on a Book value vs Market value basis  but much cheaper on Free Cashflow yield and Earnings Yield relative to the index.  You can’t have it all so we are focusing on the cheaper companies on an earnings or cashflow basis rather than based on book values or dividends.

International equity value features - Nucleus Wealth v the index

International equity value features – Nucleus Wealth v the index

Source: Factset, Nucleus Wealth

From a dividend perspective we are earning a higher yield, but at the moment this is more of an outcome than part of the process – there is a global hunt for yield which is pushing a range of traditionally high yield stocks into expensive territory.

Quality Exposures

For the Quality axis, we use a broad range of factors including:

  • Economic Moat: High margins, high returns, high proportion of earnings converted to cashflow
  • Economic Trajectory: High marginal returns, above average EPS growth, sustainability of economic moat
  • Stability: Earnings, cashflow, dividends, share price
  • Financial: Appropriate gearing, interest cover

Currently we are finding that lower volatility stocks are expensive. While we prefer stocks with low volatility, we are not going to buy them at any price and so our portfolio currently has a beta very slightly higher than the market – usually it is lower than the market.

International equity features - Nucleus Wealth v index

International equity features – Nucleus Wealth v index

Damien Klassen is Chief Investment Officer at the Macrobusiness Fund, which is powered by Nucleus Wealth.

The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Integrity Private Wealth Pty Ltd, AFSL 436298.

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  1. What about Real Estate in the several US cities that are growing as fast as anything out here, yet keep their median multiple at around 3 by highly elastic supply of urban land – and extremely efficient development and construction, including new infrastructure? Just look for honest rental returns, and when it comes to asset value, you know you’re not paying top dollar for bubble values and they aren’t gonna crash and wipe you out. Even if they fall, the bottom won’t be very far down, and the recovery will be as good as it can be, due to local regulatory culture being pro-business.

    Then there is the “rust belt” low-price city like Detroit, where investors are buying up whole blocks of houses that are worth nothing, because there is every chance of a grassroots revival, and even evidence that it is well underway already. Investors who have assembled large blocks of adjacent properties will be well-placed to turn them into something with a lot of value-added.

    • Sounds like the equivalent of penny stocks to me. And is there some the added risk that you are up for costs (maintenance / debt / rates / tax) even if the land remains effectively worthless?

  2. What is MB’s take on the increase in iron ore prices ? Are you still predicting $40 by the end of the year ?

  3. bigpadaricoMEMBER

    MB, I feel confused about our relationship. As an investor, I’m interested in your product. As a reader and citizen, I’m worried that you’ll now inevitably become just another “independent” source cheer-leading for its own vested interests. Have you become the very thing that you set out to destroy? Am I missing something? I hope so.

    • Damien KlassenMEMBER

      It’s a valid concern.

      The goal is to be painfully (from my perspective!) transparent and rely on our readers to call us out whenever you think we are being subverted by conflicts.

      We have purposefully chosen the structure to avoid as many conflicts as we can. We chose to have a flat fee rather than charge more for some asset classes than others – for example we could have chosen to charge more for international investments (to reflect the cost of the research) and a lower amount for bonds. We instead chose a flat fee so that we have no conflicts – we put investors into the asset class we believe suits them rather than the one that pays us the most. We also chose direct investments (for larger balances) so that we avoid 2 layers of fees, and also avoid the potential to be influenced by product providers.

      Time will tell if we can manage the conflicts – please speak up whenever you think we have a conflict that we are not clearly relaying to readers.

      • bigpadaricoMEMBER

        Thanks for the reply , Damien. Big tick for acknowledging the risk and dealing with it proactively. I do hope you guys manage to pull it off, because you’re filling big holes in two markets (media and investment) that an increasing number of us want to see plugged.

  4. Pester hasn’t the time to do the analysis you do and so I need to take that on board. Over the long term we need risk asset exposure or we get left behind. But my roadblock is my back of the envelope risk metric: Risk exposure is (1) Aussie budget deficit (2 ish) x (2) the percentage reduction in Euro stock dividend yields over the five years to date. = risk through the roof. The rate of dividend yield collapse is now bigger than it was going into 2000 and Dr Yarendi shows us all the buy back tricks etc in play now to keep div yields even where they are. Add the fact that US recessions are 70% correlated with big famines and you see you could easily be toast on the back of a random wheather event. Yes the retraction of Euro government spending to GDP if it continues provides breathing space but isn’t attractive enough unless a big dip opens up. ANYBODY?

    • Damien KlassenMEMBER

      Yep – Linear (the platform) has the official performance stats. We will be releasing quarterly stats on the blog.

      • innocent bystanderMEMBER

        I have visited Nucleus Wealth and seen nil.
        Maybe the MBFund Pilot transaction and performance history could be posted?
        I registered interest several months ago and, like others, heard nothing back.

      • Damien KlassenMEMBER

        Apologies innocent bystander – will get Tim in contact with you.
        Unfortunately ASIC is extremely strict on reporting prior performance for new products. We are limited to performance since we were taking money for MB clients, so the performance reporting will only begin from this financial year.
        No-one wants to publish our pilot portfolio performance more than H&H – but we also want to keep our licence! We can point you to our published portfolio positions but that is all we can do.

      • I could not find any performance stats for Nucleus funds on Linear website, looks like the fund has not been running for over a month yet?

  5. Uptown Funks post got the chop. I guess it was a bit rude, but I always like to read his upbeat posts about the ASX 200, which run counter to the echo chamber views usually expressed on MB.

    • ………..and, are the 56 (?) crosses in Chart 2 your chosen investments? How many are ASX-listed?
      ………..and, if you are intending to report MB fund performance against MSCI World Index, will you do it in US$ and/or A$ terms?

    • Damien KlassenMEMBER

      Yes, the dots are the MSCI constituents.
      There are 70 stocks currently in our international portfolio of which none are ASX listed. If you register at https://portal.nucleuswealth.com/login?mb and follow through the application, we show at the end of the process the full portfolio. Once you are invested you can log into the portal and see the stocks in the portfolio at any time.
      The diagram is actually from earlier in the year – the current portfolio is similar, I just took this diagram from a presentation.

      We have a separate Australian portfolio if you are interested in just Australia but the lines are very different as there are only around 70 stocks in the MSCI Australia Index so its more about avoiding the top right of the chart.

      All reporting from the platform is in $A. We will be running USD performance for our own purposes, we may publish USD numbers from time to time for information.