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In defence of Global Equities

02 March 2007 Nedgroup Investments

Global equities have had a bad press in the 21st century. Global equity markets began on a technology-fuelled high and slid downwards, as measured by the major indices for the next three years until the gloom created by the start of the Iraq war had taken them down to levels at which all sellers had sold. Since then there has been a considerable recovery, which can now justify being called a bull market, accompanied by a rather muted revival of confidence in the prospects for the asset class on a longer term view.

Meanwhile other types of investment such as hedge funds, direct property, private equity and ultra-long bonds have captured disproportionately larger parts of investment flows. So why should we consider equities seriously?

Equities are an essential part of the financial system. Somebody has to own the "first loss" part of any financial structure, in this case normally the liability side of a companys balance sheet. Because of their vital role at the bottom of the structure they should produce the higher returns due to them, and generally have done so. This also means that there will always be demand for equity finance, even if it is packaged in different forms by, for example, private equity firms.

The quoted equity markets represent an astonishing range of corporate opportunities, which vary enormously by region, country, industry and scale. For example, an investment in the energy sector could take the form of shares in a multinational such as Exxon or in a start-up such as White Nile, which explores for oil in the Sudan. The enormous diversity creates wide dispersion of return patterns. It is worth remembering this in the context of the bear market of 2000-2003. Many companies survived its onslaught very well, even in countries where the technology spending recession bit hard. Some sectors and indices made new highs, even as Cisco, Microsoft and Intel were dragging the S&P500 index lower. As an extreme example, the Russian equity market was sharply higher in both 2001 and 2002, while the major indices fell sharply.

Participation in equities is relatively cheap, easy, liquid and transparent. At the extreme an investor can buy direct, in which case execution-only commission is the main cost. Most equity investment funds carry relatively low fees, particularly compared to the cost of holding equities through long/short hedge funds or private equity. Exchange-traded funds, index-trackers and many closed-end funds are particularly good value provided they give access to the chosen area of the market. Liquidity in either direct equities or in funds is very good. Excellent transparency is provided through periodic audited reports produced by both companies and funds. With the advent of the Internet the wealth of information available for analysis is huge.

So are equities currently attractive? Equities around the world are not particularly expensive compared either to their historic valuation or to bond markets. Of course, it is not guaranteed that recent healthy rates of earnings growth will be sustained. Other asset classes, notably property and bonds, in our view, have become decidedly less attractive. Sentiment toward equities has clearly improved but there are still plenty of sceptics around who have to become bulls before markets come under real pressure again. Global GDP growth remains healthy and attractive opportunities exist in many markets. In the current geopolitical environment there are always reasons to worry, but there is an inherent flexibility in equities which makes them survivors in a way that bonds and property may not be in extremis. In the medium term, there could be pressure on profit margins. But so far in this cycle, companies have been disciplined, the opportunity set is very large and we are highly confident in our managers' ability to exploit these opportunities.

By Larry Jones and Patrick Gifford, Nedgroup Investment Advisors (UK) Limited

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