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The old adage is “don’t have all your eggs in the one basket”. In terms of investing that is sage advice, but even more so in a period of unprecedented global economic turmoil.
2020 has seen very wide divergence in performance between equity sectors, geographies and individual stocks. The worst asset allocation you could have had was to be 100% invested in large cap Australian equities in Australian dollars. The weighting of widely held Australian banks has played a key role in that poor performance.
I have been banging the drum about the diversification attractions of leading global equities for years. The first slide in my AIM presentation deck is “why global” and it’s never been more pertinent than right now.
Just to remind everyone if you only invest in Australian equities, you limit yourself to just 1.9% of the worlds listed equity investment opportunities. You’ve basically turned your back to the other 98.1% of the global listed equity opportunity set. To me, that isn’t sensible.
Similarly, if you only invest in Australian equities, you limit yourself to a market that is dominated by financials and resource stocks, both of which have unfavourable performance characteristics in a global recession.
However, most importantly, if you only invest in Australian equities, you are resigned to the fact your portfolio will not have technology stocks, with information technology and communication services grossly underrepresented in Australian vs. global and US equity benchmarks.
Finally, if you only invest in Australian equities it means the only currency you have exposure to is the Australian dollar, a commodity currency linked to global growth prospects and Chinese demand for our natural resources. The Australian dollar is -7.7% vs the US dollar in 2020.
To reinforce to you the power of diversification in 2020, I thought it would be worth noting the performance of a selection of leading global technology companies in Australian dollars . These are the returns unhedged Australian investors have generated in what are household technology names, many of which you would use in your own life every day.
The NASDAQ Composite Index is +9% in AUD for 2020, while the ASX200 is -20%. CBA is -25% and WBC -37%, for example. Home bias has cost Australian investors dearly in 2020 and will continue to, as we slowly emerge from COVID-19 lockdowns.
The point is you didn’t have to take high risk to achieve solid positive returns from diversification to world leading technology companies, most of which are listed in the United States. You simply had to own a smattering of the world’s best mega cap technology stocks, while avoiding anything deeply cyclical or financial.
Thankfully my AIM Global High Conviction Fund has been unhedged to the Aussie dollar and well exposed to leading global technology stocks. While we don’t have all our eggs in the global technology basket as such, the exposure has driven positive CYTD returns and positive FYTD returns and more than offset any falls we have experienced in consumer facing investments. We are also well ahead of benchmarks.
The reason we remain attracted to leading global mega cap technology stocks is unchanged. They produce the best returns on their capital base. I’ve shown you this table before but today I think it’s more relevant than ever. It’s a proprietary AIM table and it shows how much capital a given sector requires to operate and the returns they generate from that capital.
The thin green bar is Information Technology, the big flat fat grey blob is Financials. This return on capital deployed analysis is why we own no financials and have 25% of the fund in IT. Financials simply don’t make an acceptable return on the capital they have deployed. If you’re wondering why NAB shares are the same share price as 25 years ago, refer above.
The other clear attraction of mega cap global technology stocks is balance sheet. There are fortress balance sheets that own between $20b and $150b of cash. In a time of economic crisis those fortress balance sheets are a huge strategic advantage. It also allows mega cap global technology stocks to continue with large cap stock buyback programs, funded from free cashflow.
Today I though you may find a quick summary of the recent Alphabet (GOOG.US) result, which illustrated the resilience and strength of this great business model.
Alphabet was somewhat emblematic of a pattern that repeated itself with many of the businesses we own: a strong start to the year, followed by a rapid decline in revenues from March onwards as lockdowns began to be enforced around the world.
Being in the advertising business, Google was squarely in the firing line of the economic impact of the global lockdown measures as marketing budgets were being cut across the board – particularly in the travel sector, which makes up a substantial component of Google’s revenue.
However, the business proved more resilient than feared; revenues were still up by around +13%, though the business experienced a substantial contraction in demand in March. Importantly, management indicated that there were some tentative signs of the decline in year-over-year revenues stabilising in the mid-teens levels – well above the worst-case outcomes many had modelled for. Importantly, because search provides a measurable return on investment for advertisers, it is likely to bounce back relatively sharply once businesses re-open and need to attract the marginal consumer/buyer. If anything, Google’s ability to target potential buyers makes their service arguably more valuable during a time of economic distress, even as overall ad budgets are in decline.
Beyond Search, YouTube is also experiencing a substantial increase in engagement as many users are stuck at home, though brand advertising revenue spending has weakened over the period. Despite this dynamic, revenues still grew by 33% year-over-year, indicating the resilience of this part of the platform.
Google Cloud Platform also reported solid revenue growth as the rapid shift to remote working and education benefited this line of business. G Suite – the suite of productivity applications offered by Google, comparable to Microsoft Office – also saw increased uptake.
This result showcased the benefit of the other revenue streams the business has cultivated over the years. While the primary driver of revenues is still online advertising, the mix of businesses provides some diversification during times of distress.
The company still has a fortress balance sheet ($120b cash), and little debt. Even if revenues decline for a period, there is no doubt the business will survive, and in our minds further entrench its competitive position.
While mega cap tech has done very well in 2020 for a variety of fundamentally justified reasons, my view remains that this is a sign of things to come in terms of a recognition that in the new world we are entering these are the business that the world simply can’t open for business without. Mega cap Tech is the new “defensive” sector, particularly so when you take balance sheet into account.
If ever there was a case for portfolio diversification and losing a bit of the home bias, it is right in front of you in 2020.