NEW YORK, Oct. 13, 2015 /PRNewswire/ -- With U.S. equity markets reaching all-time highs in 2015 yet facing increasing uncertainty and volatility, investors seeking to diversify and identify new opportunities should consider widening their focus globally. This is only underscored by the international equity situation, advises portfolio manager Chris Floyd of Legg Mason affiliate QS Investors.
"We are potentially witnessing the beginning of a large momentum change in international stocks," Mr. Floyd said. "The U.S. has outperformed other countries for a long while, but with U.S. markets down four percent for the year – while Europe is up 1 percent and Japan 6 – this is a good time for strategic diversification."
QS Investors believes in the value of diversification across geography and asset classes.
"Well-chosen global equities can offer better long-term returns and lower risk," Mr. Floyd said. "We think this is a time for investors to break through their home country bias. Investing in nothing more than U.S. mutual funds means missing significant opportunities. The U.S. accounts for only roughly one-quarter of global GDP, and only 37 percent of total global equity market capitalization. There are lots of strong opportunities waiting out there for smart investors."
The QS Investors team's analyses of individual stock fundamentals, such as valuations and analyst revisions, suggest that this may be a good time to add to international equities.
"By virtually every measure, particularly price-earnings ratios, U.S. stock prices look expensive," Mr. Floyd reported. "Dividend yields are higher outside: three percent, versus two percent in the U.S., which is important in a low interest rate environment. Earnings revisions are also a key differentiator. We are still seeing positive consensus earnings revisions in places like Continental Europe and Japan, while revisions for U.S. stocks have turned negative."
Some of the shift in attractiveness stems from what Mr. Floyd called "tactical considerations." "While the U.S. Federal Reserve has a tightening bias, Europe and Japan are pursuing more quantitative easing," he said. "This is a tailwind for foreign equity markets that we do not see letting up any time soon."
In terms of country markets becoming more attractive, Japan topped QS Investors' list.
"Both monetary and fiscal policy are supportive in Japan right now," Mr. Floyd explained. "They have started to change their persistent deflationary mindset, which has led to benefits at both the macro and individual company levels. In addition, the Japanese Government has signaled that further fiscal stimulus is coming. An expected lowering of the corporate tax rate next year should flow through directly to improved company profits."
Long known for its companies being indifferent if not openly hostile to shareholders, and historically unwelcome to hostile takeovers, Japan's culture is exhibiting signs of change.
"It all starts and stops with corporate governance, which is becoming much stronger now," Mr. Floyd said. "The cross-shareholdings that characterized the Japanese economy are unwinding and shareholder buybacks are improving. Companies must demonstrate stronger return on equity and a focus on shareholder returns. A new index has been created to track companies' progress; to be excluded is a form of public shaming. The government is encouraging change with its own investments too."
"As a result we believe many Japanese stocks are valuable investments, now and for the future." When considering broad global markets, Mr. Floyd stated that QS Investors' stock selection models prefer small and mid-cap stocks to megacaps going forward.
"Valuations are generally better," he explained. "Many small and mid-cap companies have strong cash flows and represent better earnings growth opportunities. It can be difficult to judge these kinds of key factors in some markets, however, given complexity and culture. Thus we recommend investors rely upon professional managers for advice on international equities."
QS Investors believes that expanding the investment universe to include smaller and mid-sized companies can provide strong opportunities for outperformance.
"An example is Pandora, in Europe," Mr. Floyd said. "They're Danish and best known in the U.S. for making charm bracelets: 'I speak Pandora.' A mid-cap with a turnaround story, they tried to go upscale but it didn't work; sales took a hit and they had a lot of unsold inventory."
"To management's credit they realized their mistake and refocused, expanding their geographic presence instead. A well-regarded stock had a stumble but now has positive earnings growth and an attractive valuation. It's the type of opportunity investors miss if all they do is focus on megacaps."
For similar reasons QS Investors also likes NXP Semiconductor, based in the Netherlands.
"We found NXP when they were a mid-cap, before Apple put their near field communication chips in the iPhone 6," Mr. Floyd said. "Their chips help make ApplePay work and the huge success of the iPhone 6 launch gave NXP a big boost. They are showing good momentum with their recent acquisition of Freescale, which diversifies their automotive semiconductor business. We think NXP remains a strong growth opportunity."
No analysis of international equities can be complete without the energy sector.
"We have been underweight on energy stocks, particularly the biggies," Mr. Floyd reported. "However, the story is looking a little played out and ripe for reversal, so on a relative basis energy may be becoming interesting again."
When looking beyond the developed world to emerging markets, QS Investors is cautious.
"On emerging markets, we have been less positive as a consensus call," Mr. Floyd said. "We are avoiding Russia and Brazil because the end of the commodity boom has bitten harder than expected. With China we have minimal exposure, less than before the Financial Crisis."
QS Investors is nonetheless pursuing opportunities in some EM countries, in keeping with a shared Legg Mason focus on both top-down macro analysis and bottom-up stock picking.
"On the positive side, we generally like Taiwan," Mr. Floyd said. "It offers stability, good growth and healthy diversity for downside management. That's a key selling point."
"India too, with a new government and opportunities for structural change. They may be moving slower than hoped but we find India attractive relative to other EM markets."
Mr. Floyd emphasized diversification as the greatest reason to consider international stocks.
"How do we make the case for international investing? Growth, yes, but diversity leading to lower overall portfolio risk: that's why U.S. investors should consider international equities. Global stock markets do not move in lockstep. When the New York Stock Exchange takes a negative turn it may bring other markets with it – but not all the way."
"Investors can manage the risk of their hard-earned capital by spreading it around into different markets. They may miss a few opportunities, but they will be less likely to get hurt on the rainy days if at least some of their money is experiencing different weather."
About Christopher W. Floyd, CFA
A Portfolio Manager, Chris Ford is a member of the QS Investors portfolio management strategy group. Prior to joining QS Investors Mr. Ford worked at Legg Mason's Batterymarch Financial Management: as a developed markets senior portfolio manager, from 2012 to 2014; a portfolio manager, from 2003 to 2012; and as a quantitative analyst, from 2000 to 2003. Previously he performed market analysis at Urban & Associates and worked with retirement plans at Bay State Federal Savings Bank. A Chartered Financial Analyst, Mr. Ford has a B.A. in economics from Dartmouth College and an M.B.A. in management from Cornell University.
About QS Investors
A wholly-owned, independently-managed affiliate of Legg Mason, Inc., QS Investors, LLC was formed in 1999 as the quantitative platform of a global asset manager. As an investment firm providing asset management and advisory services to a diverse array of institutional clients, QS Investors delivers disciplined, systematic solutions that address clients' complex challenges. The QS team has developed unique approaches to integrating quantitative and behavioral investment insights and dynamically weighting opportunities in response to changing economic and market conditions. Risk identification, assessment and management are intrinsic to their process. Based in New York, QS Investors offers a broad spectrum of strategies to clients worldwide, including actively managed U.S. and global equities, liquid alternatives and customized solutions.
About Legg Mason
Legg Mason is a global asset management firm with $672 billion in assets under management as of September 30, 2015. The Company provides active asset management in many major investment centers throughout the world. Legg Mason is headquartered in Baltimore, Maryland, and its common stock is listed on the New York Stock Exchange (symbol: LM).
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