Three Considerations for Australian Investors Going into 2021
China will continue to lead the global growth recovery – emerging markets warrant investor consideration
With the US dollar on a secular decline, currency exposures and hedge ratios will become increasingly important
The trend towards environmental, social and governance investing continues to gathering momentum and should accelerate going forward
2020 saw the start of a new decade but the year didn’t quite pan out as expected. COVID-19 has severely tested the global economy and markets in 2020. While uncertainty reigned supreme, markets showed surprising resilience, supported by monetary and fiscal stimulus – despite the lack of earnings. Low interest rates and more quantitative easing could be a powerful combination that prevents bond yields from moving up too much, supporting equity markets through an elevated equity risk premium (ERP).
Meanwhile, the liquidity unleashed to fight the crisis has triggered questions about the inflation outlook while policy uncertainty persists following tense US elections, with international trade relations set to be a key focus going
forward. Social issues also came to the forefront in 2020, increasing the focus on ESG (environmental, social and governance) investing.
As we move into 2021, uncertainty persists on many fronts but we believe the following themes warrant consideration:
Economic growth is expected to recover in 2021 but certain countries and regions will lead the way. At the front of the pack is China, which was the only major economy to still show positive growth in 2020. Having experienced the COVID-19 crisis first, China has also been the first to recover and, with strict measures in place to contain the virus, has reduced the likelihood of further outbreaks.
This year, quantitative easing and balance sheet expansion strongly supported equity markets, but earnings have not followed yet. However, we expect resilient earnings growth in Chinese equities to help support the broader emerging market complex. Digitization and consumption trends also support a reconsideration of emerging market equity exposures in general.
The SPDR S&P Emerging Market Fund (WEMG) provides exposure to medium and large companies listed on stock markets from approximately 20 emerging markets including China, which represents about a third of the fund.
Source: JP Morgan, Bloomberg Finance L.P.as of 31 October 2020
Currency has always been an important consideration for Australian investors, especially when looking at their international equity exposure. Typically, foreign currency from a domestic perspective is thought of as a risk diversifier. But from a valuation perspective, investors should re-consider their currency exposures and hedge ratios. The US is about 60% of the S&P World ex Australian Index, giving it a large US dollar (USD) exposure. With the USD weakening as a result of narrowing yield differentials and a ballooning public deficit, it could be entering into a multi-year bear market. That may lead to relative gains for the Australian dollar (AUD). With the AUD currently undervalued, unhedged investors can look to consider introducing currency hedges while investors with hedged exposures already in place should re-assess their hedge ratios.
The SPDR S&P World Ex Australia Fund (WXOZ) and the SPDR S&P World Ex Australia (Hedged) Fund (WXHG) provide investors with the flexibility to manage their currency exposure and hedge ratios.
Source: State Street Global Advisors, MSCI, Bloomberg Finance L.P., as of 31 October 2020. Estimate of fair value versus the Australian dollar as of 31 October 2020 — valuations above 0% imply overvalued and below 0% imply undervalued. This information should not be considered a recommendation to invest in a particular currency. It is not known whether MSCI World ex AUD currencies will be profitable in the future.
The ESG investing story of 2020 has centered on the global COVID-19 pandemic, but ESG investing is gaining momentum that will likely persist long after the pandemic subsides. Additionally, investors have been attracted to the resilience of ESG stocks during the pandemic. The reasons for the robust performance of ESG funds can vary and need to be evaluated on a case-by-case basis. In aggregate, however, the extraordinary year of 2020 supports our main view: companies with superior corporate governance and better environmental and social practices than their peers display greater resilience and preserve long-term value more effectively
during times of market stress.
The SPDR S&P/ASX 200 ESG Fund (E200) provides investors with exposure to the largest 200 Australian listed companies while also tilting towards companies that exhibit strong environmental, social and governance characteristics and E200 excludes companies in tobacco, controversial weapons and those that earn more than 5% of their revenue from thermal coal.
Source: Morningstar, as of 30 October 2020. All figures are in USD.
The views expressed in this material are the views of Raf Choudhury through the period ended 30 November 2020 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Investing involves risk, including the risk of loss of principal.
Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
Companies with large market capitalizations go in and out of favor based on market and economic conditions. Larger companies tend to be less volatile than companies with smaller market capitalizations. In exchange for this potentially lower risk, the value of the security may not rise as much as companies with smaller market capitalizations.
Currency Risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged. Currency Hedging involves taking offsetting positions to reduce exposure to different currencies. These currency exchange contracts may reduce or eliminate some or all of the benefit that an investment may experience from favorable currency fluctuations. There can be no assurance that the Fund’s hedging strategies will be effective.
The returns on a portfolio of securities which exclude companies that do not meet the portfolio's specified ESG criteria may trail the returns on a portfolio of securities which include such companies. A portfolio's ESG criteria may result in the portfolio investing in industry sectors or securities which underperform the market as a whole.
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