Pathfinder Monthly Commentary
Investing globally – may the force be with you…
Monday, August 5th 2013, 8:30AM
by Pathfinder Asset Management
The total market capitalisation of domestic companies listed on the NZ stock exchange is NZ$52 billion. While this seems like an enormous amount of money, it is small in a global context. In fact the NZX capitalisation is close to zero (only 0.06%) as a proportion of global equity markets. In this commentary we look at the significance (or otherwise!) of the NZ market – and share thoughts about why some international diversification is important for investors.
1. The NZ and US markets compared
The market of all US listed stocks is 37 times larger than the NZ market (measured by the number of stocks in the NZX All Index). Based on market capitalisation the size difference is even more massive – the US market is 486 times larger. Here is a quick look at the relative scale of the NZ and US markets:
New Zealand is a concentrated market dominated by what are recognised globally as small and mid cap stocks. A few key examples:
• NZ is dominated by a few stocks: the top 5 stocks comprise 37% of the NZX50 compared to only 11% of the S&P500.
• NZ market is not diversified: The S&P500 has no stocks above 3% of total market cap compared to NZ which has 10 companies exceeding 3%.
• US companies are large: 87% of S&P500 companies are classified as “giant” or “large” cap. NZ has no companies in this category. The average US listed company is 13 times larger than the average NZ listed company.
• NZ companies are small: All of NZ’s companies are classified as “medium”, “small” or “micro” cap. Only 13% of S&P500 companies fall into this category.
An alternative perspective is to consider what if the entire NZ market was merged into a single company and listed in the US. This NZ mega company would be the 87th largest S&P500 company - there are 86 US companies bigger than the entire NZ market!
2. Thoughts on a small economy
The concentration of New Zealand’s equity markets are also reflected in the wider economy. NZ is very reliant on one producer for export income - Fonterra is responsible for 25% of our merchandise exports. This puts us (along with Finland and South Korea) at the extreme end in the developed world for export reliance on one entity. Here are some comparisons:
Larger economies are more diversified exporters. For example compare Fonterra’s share of NZ exports (25%) with the largest exporter from the US (Boeing at 5%). In Japan the top 5 exporters combined are responsible for 20% of exports – less than Fonterra alone for NZ.
Would you consider investing in a portfolio where 25% of corporate revenue came from one stock in the portfolio? That doesn’t sound very diversified. But that is the kind of concentration risk investors take when they choose New Zealand as their sole or dominant geographic equity allocation.
Below is a quick look at the place in the economic world of NZ relative to others. You will see the global importance of the US (based on its market cap and GDP) vastly exceeds the significance of its population. China is in the reverse position. By comparison NZ is a rounding error (less than 0.5%) on each measure:
The New Zealand economy is small and lacks diversification. It is understandable for investors to favour investments that they can understand, easily access and are close to home. However, in terms of country risk there is a clear need to consider diversifying outside New Zealand (and also beyond Australia).
3. Thoughts on a small equity market
The NZ equity market is, like our economy, small and concentrated. Our market also has a focus on defensive industries and stocks. While this is helpful for many investors as our larger companies generally pay healthy and stable dividends, this is not ideal from a growth perspective. By comparing the make-up (based on number of companies) of the NZX50 to the S&P500 we see NZ’s overweight bias for defensive stocks and underweight bias for growth stocks:
The S&P500 has a range of industries and sectors not represented in the NZX50 or only represented by 1 or 2 companies. These include key industries such as automotive and pharmaceuticals. Investing in a market like the US provides a greater focus on growth companies and opens up industries and sectors where access is restricted in NZ.
4. Final thoughts
What does this tell us? Below are some points to ponder:
Some global equity exposure makes sense: Both NZ’s economy and listed market are (on the global stage) small and concentrated. Diversification away from NZ reduces the risk of financial, political or climatic shocks inherent in a small economy.
The US market is very different: NZ’s listed market doesn’t have the same spread of industries or depth of growth opportunities as the US. In fact we have quite the opposite – a much higher proportion of lower growth defensive stocks such as utilities, infrastructure and property. The US is not just larger - it presents entirely different opportunities for investors.
Be aware of the home country bias: Wanting to invest locally is entirely rational – it allows an investor to stick with what they know, understand and can access easily. But investors should challenge their home country bias and research opportunities in larger, more liquid and more diverse markets.
John Berry
Executive Director
Pathfinder Asset Management Limited
Pathfinder is a fund manager and does not give financial advice. Seek professional investment and tax advice before making investment decisions.
Pathfinder is an independent boutique fund manager based in Auckland. We value transparency, social responsibility and aligning interests with our investors. We are also advocates of reducing the complexity of investment products for NZ investors. www.pfam.co.nz
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