Goldman Sachs Asset Management chairman Jim O’Neill has countered such thinking, arguing that “the link between GDP growth and equity returns is, in fact, very strong”.
“We find that equity markets are a lead indicator of GDP growth and react strongly to expectations about the future. Changes in consensus GDP expectations are likely to influence equity prices,” O’Neill’s GSAM team said in a recent strategy note.
“While there is considerable diversity across countries, in general the sensitivity of equity returns to future growth forecast revisions appears to be much higher in the growth markets than in the advanced world”.
More fund houses are starting to pay attention to the relationship too, if the launch of the PSigma Global Equity Fund this week is anything to go by. Skandia Investment Group’s Global Dynamic Equity and Global Best Ideas funds, meanwhile, have used a GDP-weighted benchmark since their respective launches in 2009 and 2006 respectively.
PSigma’s offering selects stocks from the MSCI All Country World Index but will use a GDP-adjusted weighting as a tool for individual stock sizing, country and regional weights. SIG portfolio manager Ryan Hughes says GDP weightings should be used as “a starting point” but believes active managers should still have plenty of work to do from that point.
Valuations
For O’Neill, the recognition that equity markets price in future growth “places a renewed emphasis on valuation, in addition to growth expectations and growth sustainability”. The GSAM team say some current and prospective growth markets “still have the potential for higher and more sustainable growth and upside growth surprises that are not yet reflected in equity valuations”.
The team acknowledge that the link between GDP growth and returns, while strong, is not straightforward. “Sceptics might argue that over the past decade equity markets have fully priced in the potential for upside growth surprises in traditional emerging markets, leaving little upside for growth stories and equity markets”, they note, before suggesting such arguments do not hold for all countries. GSAM’s suggestion that investors should look to growth expectations, rather than pre-existing growth rates, further emphasises the fact that a simple reliance on GDP is no kind of panacea in itself.
James Abate and Jing Sun, managers of the PSigma fund, point to the performance differential between the MSCI ACWI Index and its GDP-weighted version, and say that $1 invested on 1 July 2000 would have produced $1.06 in the standard index by 30 April 2011 (assuming no income was reinvested) but $1.33 in the GDP-weighted index.
However, here too the relationship is not always so straightforward: Hughes notes that the MSCI ACWI GDP index underperformed the conventional MSCI ACWI last year, but says that alpha generation meant SIG Global Best Ideas was nevertheless able to outperform the latter index.
Stability
Hughes says another advantage of such processes is the inherent stability of the MSCI All-Countries World GDP Index, which is recalculated on an annual basis. “It means you don’t get bounced around by movements in the benchmark”, he says.
That recalculation process has, however, just taken place, and will have an impact on the target asset allocations for the Global Best Ideas and Global Dynamic Equity funds. The rebalancing has unsurprisingly seen a reweighting in favour of developing markets.
In the case of the Global Best Ideas fund, which has a default 50% weighting to the UK, Europe ex UK will now account for 12.5% of the portfolio, down from 13.2%, and the US share is down from 15.3% to 14.2%; Asia-Pacific ex Japan now accounts for 7.8%, up from 6.8%, with Emerging Markets up from 9.3% to 10.3%. The target asset allocation for Japan remains 5%.
Global Best Ideas currently has five UK mandates and one mandate for each of the regions mentioned above; Hughes suggests this balance will eventually need reassessing as developing market growth continues: “It’s a question we need to ask in time. It is not a specific issue right now but that’s not to say it’s not going to change in future”.
