The case for international equities to break US cycle: Principal AM

Investors have been encouraged to “take a fresh look at the international equity market” for opportunities other than in the US, as new commentary from Principal Asset Management confirms other global markets have managed to “keep pace”.

George Maris, CIO of Global Equities at Principal Asset Management, said both India and Japan had kept up with the NASDAQ over the last few years and may offer ‘bottom-up’ opportunities for investors seeking “easier monetary policies, stronger global growth and aggressive pro-market reforms”.

“In today’s environment, international equity investors should focus their efforts on economically sensitive sectors and markets. Recent substantial government measures, including monetary easing and stimulative fiscal policies, bolstered pro-growth activities and benefited strong, competitively advantaged companies,” Maris said.

“There are promising examples of companies generating resilient free cash flow growth and trading at attractive valuations in sectors like mining, defence, and insurance, offering investors attractive equity opportunities outside the U.S.

“Equity investors are best served by identifying companies where free cash flow growth is underestimated by the market. Unlike earnings, EBITDA, and other metrics, free cash flow genuinely reflects a corporation’s economic strength as it captures the cash generated relative to the cash invested in a company’s growth and expansion.

“When identifying international investment opportunities, leveraging free cash flow enables investors to strip away local differences around accruals and assumptions and differences across sectors, industries, regions and countries. Investors can assess future investment success by drilling down to forward cash-generating power.

“Building on this focus, implied alpha plays an equally critical role in constructing international equity portfolios than traditional measures, which generally focus on absolute positions relative to the benchmark. In contrast, implied alpha considers the cross-volatilities of each security across an entire portfolio, offering a clearer and more precise measure of capital at risk for individual positions.

“So, active managers can allocate capital deliberately and target the best risk-adjusted return potential for each position. This should facilitate building a portfolio with greater resilience and a higher potential for alpha over time. Implied alpha is particularly effective in bottom-up international equity portfolio construction as it allows for greater insight across geographic boundaries.”

Maris also highlighted the opportunities with ‘depressed valuations’ lying in the UK and Chinese markets. As the UK continues to suffer the trailing effects post-Brexit and Chinese stocks are coupled with “longstanding economic structural issues, geopolitical tensions and concerns around the rule of law”, Maris said the “risk-reward set-up is intriguing”.

“As investors position themselves in international equities today, they do so amid healthy corporate balance sheets, attractive fundamentals, and constructive fiscal and monetary policies. These facets should underpin earnings growth and drive market sentiment,” Maris said.

“While challenges and risks persist in the international equity space—most notably ongoing economic weakness in Europe and parts of Asia—the depressed valuations in these regions create attractive entry points for investors in firms demonstrating strong free cash flows.

“These bottom-up opportunities, combined with easier monetary policies, stronger global growth and aggressive pro-market reforms, are a powerful combination of events supporting international equities and helping drive broad outperformance.”