With corporate growth expected to be low in most markets in the coming years and valuations relatively high, many commentators are predicting low returns for equity investors. As such, there is an increased focus on identifying excess return, acknowledging its importance for investment returns. This paper examines the evidence for (diminishing) excess returns in global equity strategies and considers whether this undermines the case for using global equity mandates to implement an equity structure.
This paper examines the evidence for excess returns in global equity strategies and considers whether this supports the case for using global equity mandates to implement an equity structure.
One of the clearest trends over the past decade has been for institutional investors to diversify their equity exposure away from a single (often the domestic) market to a global allocation. The reasons for doing this typically relate to the narrow (and often volatile) nature of many domestic markets and their benchmarks, and the diversification benefits of a “global” approach (the exception is, perhaps, the US, which is a much broader and more diversified single market).
Mercer has for many years recommended the implementation of a global equity allocation by using a series of strategies with global mandates rather than a combination of single-country or regional strategies. Our most recent advice focuses on a core allocation to broad global mandates that are diversified across a series of factors augmented by small-cap, emerging markets, and low-volatility mandates. The reasons for this broadly fit into the following categories:
- Higher excess return potential
- Ease of implementation for clients
For some clients, there are reasons why a domestic focus or regional implementation of a global equity structure may be the most effective way of accessing equity markets (for example, tax or currency considerations, or knowledge of the local market). There are highly skilled single-market managers who can play a key role in an investor’s equity portfolio. In addition, specifically within small-cap equities, there is evidence of consistently high excess return within regional/single-market universes.
Equally, opportunistic allocation to specialized managers can provide an efficient way of accessing beta and excess return when specific opportunities arise (if the asset owner has the skill to identify the opportunities and the governance structure in place).
Long term there is little evidence that regional or single-country mandates produce systematically superior excess return. Mercer continues to believe that, for most investors, the merits of investing globally (highlighted at the start of this article) are best implemented using broad global mandates. In fact, we expect this trend to broaden further as we see global mandates continue to move from developed market benchmarks to benchmarks that include emerging markets.
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