Magni Helps Overcome Limitations in International Investing

February 2015

While international equities are an important part of a diversified portfolio, three limitations hamper the quality of choices that investors have:

  • Most active managers underperform their benchmark over time
  • Passive approaches using cap weighted, fundamental, or other indexing strategies tend to overweight their holdings in underperforming countries
  • Buying individual stocks may be complex, difficult, and involve making decisions with limited information

In this article we discuss how existing investing strategies may fall short and how Magni Global Asset Management has pioneered a way to measure qualitative factors that impact the future of how international investing will be measured.

Staying Active Is Not Necessarily Better

While the debate over the relative merits of active versus passive investment strategies continues, the data shows a clear pattern. The S&P Indices Versus Active Funds (SPIVA) publishes important data that tracks the percent of funds underperforming over time. Though exact percentages tend to vary depending on when the data was compiled, a majority of actively managed funds underperform their index. The chart shown below shows that two out of three active managers across major classes of equities underperform during a five-year period. Active managers did best in domestic equities over a one-year period when 60% underperformed. This sort of data helps explain the strong trend toward passive and semi-passive funds.

SPIVA S&P Versus Active Funds 6/30/14

Pay Attention to Concentration

Passive managers frequently use weightings based on market capitalization. In international equity portfolios, these weightings can cause large concentrations in relatively few countries. Further, those countries may not be among the top performing countries within the portfolio. The chart below shows that the MSCI Emerging Markets index recently had more than 65% of its allocations in the five countries which had the largest market capitalization. Those five countries represented only one of the top ten performing countries in the emerging markets on both a one-year and ten-year basis. In other words, this market capitalization weighted fund overweights underperforming countries.

Top 5 MSCI Weightings 12/31/14, Top Performing Emerging Markets

Fundamental Indexing Does Not Overcome Concentration Concerns

Fundamental Indexing has become a popular investment strategy and is frequently mentioned as a Smart Beta strategy. These strategies can have similar concentrations as market capitalization based strategies. For example, the chart below shows that the WisdomTree Emerging Markets fund recently had more than 70% of its allocations in five countries. Those five countries represented only one of the top ten performing countries in the emerging markets on both a one-year and ten-year basis. In other words, this fundamental indexing fund can overweight underperforming countries even more than market capitalization weighted funds.

WisdomTree EM Weightings 12/31/14

Magni Believes that Countries MatterTM and Impact Equity Performance

A different analysis is required for international equities, because country differences are dramatic and the economic infrastructure of a country has a large impact on the ability of that society to create wealth. As discussed, traditional investment analysis ignores country factors in producing earnings and cash flow projections.

For a given country, an investor must know:

  • Do financial statements accurately reflect a company’s position?
  • Do shareholders have protections and adequate controls?
  • Can company leadership make decisions confidently?
  • Will investors be able to withdraw their investments from the subject country?

The required information is not easy to find or to incorporate into the investment decision-making process. What is required is a systematic technique for collecting, processing and organizing country data and organizing it into a format suitable for guiding investment decisions.

Magni has met this need. It has developed the Sustainable Wealth Creation Principles to address these questions by examining the accounting legal, regulatory, adjudicative, and economic structures of most investible countries around the world. Its extensive research database contains data on nearly 300 factors collected over the past 15 years.

Magni uses this information to construct investible portfolios using its proprietary Country Selection Technique. Portfolios built using this process have demonstrated significant absolute and risk-adjusted outperformance.

Looking for more perspective on international investing? Download our whitepaper:  “Country Selection – A Powerful Technique of International Equity Investing” here. Follow Magni Global Asset Management on LinkedIn and Twitter @MagniGlobal, #CountriesMatter.