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Do national lockdowns and bans on overseas travel mean the end of globalisation? Not for investment portfolios.

The coronavirus pandemic will reverse globalization. 

For some it’s a prediction, for others an aspiration. The virus’ rapid spread across the globe highlighted the fragilities of an interconnected world. Turning inward, increasing self-sufficiency, decreasing dependence on global linkages are plausible responses.

While global travel certainly ground to a halt in 2020, business does not appear to have become less global. That’s the conclusion reached when examining the revenue mix of publicly traded companies, aggregated to the index level.

The world map below displays the share of revenue earned domestically for 49 markets across the globe, represented by Morningstar country indexes.[1] Estimates based on annual report data from 2020 shows only 13 countries becoming more domestically focused in 2020. Meanwhile, 29 markets became more globalized, with the share of revenues sourced outside the country increasing between 2019 and 2020. Nearly all Asian markets turned outward in 2020, despite their pandemic lockdowns. The Morningstar U.S. Market Index earned 63% of its revenue domestically in both 2019 and 2020, making it one of several countries whose mix did not change during the pandemic year. 

![morningstar indexes revenue share.jpg](/uploads/morningstar_indexes_revenue_share_48507f4e56.jpg)


## Revenue Mix of Asian Companies  

To understand the aggregate numbers, consider the two of Asia’s leading companies: Tencent (00700) and CapitaLand (C31).    

Tencent, like Alibaba (BABA) and other Chinese tech giants, is largely a domestic player. Indeed, more than 90% of the revenues for the Morningstar China Index are sourced domestic, despite its export-led economic growth model. But Tencent saw a significant increase in the share of revenues coming from outside China in 2020. Tencent has aggressively expanded its online-gaming business globally, through acquisitions like Riot Games and Supercell, and strategic stakes in companies like Epic Games, Activision Blizzard, and Korea’s Bluehole. Tencent does not attribute revenues to specific markets outside of China, but online gaming got a global boost from the pandemic.

![Tencent_Pitchbook_Data_Global_Revenue.jpg](/uploads/Tencent_Pitchbook_Data_Global_Revenue_90cf1244d5.jpg)
*Source: PitchBook Platform. Morningstar Data.*

In contrast to Tencent, CapitalLand of Singapore earns more real estate-related revenues from outside its home market. In 2020, CapitaLand saw a decline in the share of revenues sourced domestically and an increase in Chinese revenues. The Chinese economy was relatively robust in 2020.

On a global basis, technology companies like Tencent tend to be global. That is certainly the case for companies like Taiwan Semiconductor and Samsung Electronics. Healthcare, another global sector, contributes to the outward focus for markets like Denmark and Switzerland. Sectors like financial services, utilities, and telecom tend to be far more domestic. Sector weights help explain the inward orientation of many emerging markets, such as Indonesia, Egypt, and the United Arab Emirates.

## More Global for Brazil

This is undoubtedly due to Brazil’s struggles with COVID-19. As the pandemic has ravaged the country, causing the economy to contract by more than 4% in 2020 and unemployment to climb above 14%, Vale reported its share of revenue sourced from China increasing to 57.82% in 2020 from 48.55% in 2019. Robust economic activity in Chinese led to higher demand for the raw material to make steel.

BHP, the Australian mining giant, also saw an increase in revenue share from China, though the Australian equity market as a whole became more domestic in 2020, as did New Zealand's. This inward turn parallels measures both countries have taken to insulate themselves from the pandemic.  

Russia also went more domestic in 2021, likely as an effect of sanctions undermining global revenues for some Russian businesses.

## Between a Country's Economy and Equity Market
This is especially true of European equity markets. The Netherlands, Switzerland, Ireland, Denmark, France, Finland, Sweden, Germany, the United Kingdom, and Belgium all earn 70% or more of their revenues abroad. The Morningstar France Index, for example, is hardly a proxy for the French economy. Luxury-goods maker LVMH Moet Hennessy Louis Vuitton (LVMHF), the largest public company in France, derives more than one third of its revenues from Asia and roughly one fourth from the United States. Drugmaker Sanofi (SNYNF), the second-largest French company, reports the U.S. as its largest market.

The U.K. equity market already reflects the “Global Britain” envisioned post-Brexit. Just 27% of revenues are sourced domestically. Morningstar estimates that roughly 23% of the U.K. market’s revenue came from the U.S. in 2020, 17% from emerging Asia, and 12% from the eurozone.

The world’s most domestically oriented equity markets belong to emerging economies with large populations, topped by Egypt, Pakistan, Indonesia, and China. India is an exception to this rule, being far more global than China and others. This owes to IT service providers like Infosys (INFY) and Tata Consultancy Services (TCS), which both earn the lion’s share of revenue abroad, mostly in the U.S. and Europe.

Globalized revenue streams have been cited by some as reason to avoid investing internationally. If domestic companies are doing business around the globe, doesn’t that count as geographic diversification? Global interconnectedness has surely contributed to higher correlations between stock markets around the world.

But investors with significant home-country bias are narrowing their opportunity sets and eschewing great investment opportunities--companies that could even be leaders in their home markets. For example, a U.S.-based investor who doesn’t own Novo Nordisk (NVO) of Denmark is missing one of the leaders in diabetes therapies serving the U.S. equity market, while Taiwan Semiconductor (TSM) is a leading chip-supplier to the U.S. In fact, the U.S. share of Taiwan Semiconductor’s revenue increased to 61% in 2020 from 59%.

Corporate data from 2020 does not support the view that globalization is in decline. For investors, thinking globally remains critical.



[1] Index-level data is as of 30 April 2021, based on the most recent corporate filings, typically 2020 annual reports. Company-level revenue data represents 99.4% of global market capitalization across developed and emerging markets. Data has been collected for 7,311 of the 7,391 constituents of the Morningstar Global Markets Index, of which the individual country indexes are carve-outs.

Globalization Declining? Not for Investors

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For the second time in little more than a decade, policymakers around the world have been forced to take extreme measures to avert a global economic collapse. The coronavirus outbreak has shut down swathes of international commerce, put entire countries in lockdown and left governments—even those ideologically opposed to state interference—propping up private industry.

Just as after the financial crisis of 2008, central banks slashed policy rates and printed money to fund asset-buying sprees. The aim is to lower market interest rates, making it easier for companies and governments to borrow.

Our investment experts discuss the significant structural shifts that are occurring as a result of low interest rates and how investors can capture the right investment opportunities in this landscape.

The power of central banks to move markets is undisputed but their power to revive economies has never been more in doubt. Central banks’ willingness to flood markets with cash and buy corporate as well as government debt has fuelled an astonishing rebound in risk assets. But for how long can asset prices decouple from economic growth? And what are the long-term implications for the financial system?

To examine these dynamics, this report draws upon extensive desk research and in-depth interviews with practitioners in the field. The key takeaways are as follows:

- Negative interest rates and quantitative easing are the biggest monetary experiments of modern times. Abundant central bank liquidity has buoyed asset prices and generated above-average portfolio returns over the past decade.
- This has significant implications on valuation metrics such as price to earnings multiples for stocks with different characteristics within the broad market. Stock selection will remain paramount in a low interest rate environment as economy-wide growth will not likely be sufficient to lift all boats, leading to a wider difference between stock market winners and losers.
- A low interest rate environment also enhances the appeal of alternative assets, such as private debt, infrastructure, real estate and private equity, which typically require long-term commitments. The broadening sector can offer investors flexibility in risk-return profiles, as they look beyond traditional investments for returns.

For more insights, please download the report: http://imas.org.sg/public/media/2021/06/30/1999_Below_zero_-_how_low_rates_are_reshaping_the_investment_landscape.pdf



Below zero: How low rates are reshaping the investment landscape

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It can be a challenge for investors just getting started to learn how to tackle debt, start saving, or find the best ways to pay off loans. Compounded by the coronavirus pandemic, addressing your financial situation can seem even more daunting when trying to learn the basics. 

We surveyed some of Morningstar's[ Generation Z and millennial employees ](https://www.morningstar.ca/ca/news/202904/generation-z-has-the-right-attitude.aspx)to hear their thoughts around money. Here are five lessons they learnt: 


**1. Paying Down Student Loans**

At the start of the pandemic, [the Government announced](lhttps://www.canada.ca/en/services/benefits/education/student-aid/notice-covid-19.html) measures to help students, including payment freezes.

There are pros and cons to continuing payments, and many good ways to make use of the money, like creating or building an emergency fund. If you contributed to your loans anyway, you reduced your principal. Paying down student loans is typically approached in one of two ways: [the snowball method and the avalanche method](https://www.morningstar.ca/ca/news/206124/how-to-paydown-debt.aspx). The snowball method prioritizes paying off the smallest loans first, while the avalanche method focuses on paying off the loan, no matter its size, with the highest interest rate first.

Here's how one employee took advantage of the grace period:

"As the pandemic happened and the government decided to set student loan interest rates to zero, I prioritized paying off as much as I could each month. I felt that I should try to pay the principal down since I will not have any interest eating away at my overall bill."


**2. Tackling Credit Card Debt**

With fewer ways to spend, some may turn their attention to paying down debt.

When approaching any kind of debt, you may be asking yourself the same question: Where do I even begin? Morningstar's director of personal finance Christine Benz recommends taking these steps first:

1) Buy yourself some time. Does your bank offer any options to extend a grace period or reduce your interest rate?

2) Make a list. How much do you owe, who do you owe, how much time you have, and what are the interest rates?

3) Pick a strategy. Do you want to go with the snowball method or the avalanche method

Here's a takeaway from one employee who focused on credit card debt:

"It's given me a new respect for that feeling of 'getting ahead' on payments. It's given me a chance to think more about my long-term savings goals--when I was so caught up in day-to-day spending, I didn't think as much about what I should be saving that money for instead." 


**3. Creating and Maintaining an [Emergency Fund](https://www.morningstar.ca/ca/news/206579/morningstar-money-challenge-day-7.aspx)**

The pandemic helped highlight the need to be financially prepared for the unexpected.

Our investment specialists recommend these tips to get a solid footing in the event of any unforeseen circumstances:

1) Tally up your monthly living expenses, from rent to groceries. Leave out the nonessential purchases.

2) Multiply these costs by three months. This is the minimum amount you should try to squirrel away.

3) See how much you currently have and set a savings goal.

During this time, many readjusted their focus to their emergency funds. Here's what one employee realized during this time:

"I believe that having a more holistic approach to budgeting is essential. Pre-pandemic, I was only focused on one aspect of my financial plan: paying off debt. Since the pandemic, I realized the importance of building up my emergency fund and having a backup plan in case of an unexpected occurrence." 


**4. Increasing Retirement Contributions**

The pandemic pushed some of our colleagues to look long term and consider how to stay on track for their retirement. Another effective use of the extra time and funds on your side is to focus on investing in your retirement plan. The earlier you invest, the more growth potential your retirement account will have.

Here's how one employee's priorities changed:

"After graduating from college during the pandemic, my biggest concern was finding a way to earn money. Now with a job, I am leaning into more savings, including a six-month emergency fund instead of a three-month and reaching my RRSP contribution limit."

It's never too early to plan for retirement.


**5. Cutting Back**

With office closures and stay-at-home mandates, several employees who responded to our survey said they are rethinking their spending habits during the pandemic. 

Here is how an employee embraced Morningstar's mission to think and invest with the long term in mind:

"I have been spending a lot less in areas that I would have normally spent on and putting more in savings. One thing I hope to do is work on finding a better balance between savings and investing and spending while not feeling like it restricts my lifestyle." 


5 Financial Lessons for New Investors

If your main objective is to grow your money, investing can be a great alternative to using a savings account. By investing, your aim is to grow your wealth in real terms over time. To learn more about what kind of investor you are and to find out more on investing, take our investIQ test here: www.schroders.com/investIQ

Schroders investIQ: Investing in a nutshell

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# Preview

Our definition of assets and their economic value has been changing over time. In the 20th century, machines, factories, and transportation were the assets on a company’s balance sheet. Today, value is dominated by intangibles. Brands, technologies, patents, copyrights, synergies, and business models determine the lion’s share of company worth. At this point, 90% of the capitalization of the S&P 500 Index is accounted for by intangibles(1), a huge jump from 36% in 1985.

This paper builds on the technological innovation and taxation themes presented in Deep Water Waves, a paper published by the Franklin Templeton Investment Institute, to explore the definition of intangible assets and draws conclusions on the implications for investors. Further, the paper dovetails with the Investment Institute’s Franklin Templeton Thinks Equity Markets piece, Growth or value? For active managers it can be both. All things considered, the evolving treatment of intangible assets may be one of the most impactful trends in the global economy, making them impossible to ignore.

Download Summary PDF [here](https://franklintempletonprod.widen.net/content/m7kl76qvqx/original/the-quiet-undertow-of-intangible-assets-summary-a.pdf)

Download Full PDF [here](https://franklintempletonprod.widen.net/content/btfdwsz34s/original/the-quiet-undertow-of-intangible-assets-a.pdf)

###### (1) Source: Analysis by Franklin Templeton Investment Institute, FactSet. As of 12/31/2020.

<br>

# Introduction

Our definition of assets and their economic value has been changing over time. In the 20th century, machines, factories, and transportation were the assets on a company’s balance sheet. Today, value is dominated by intangibles. Brands, technologies, patents, copyrights, synergies, and business models determine the lion’s share of company worth. At this point, 90% of the capitalization of the S&P 500 Index is accounted for by intangibles,(1) a huge jump from 36% in 1985. This paper builds on the technological innovation and taxation themes presented in Deep Water Waves, a paper (2) published by the Franklin Templeton Investment Institute, to explore the definition of intangible assets and draws conclusions on the implications for investors. Further, the paper dovetails with the Investment Institute’s Franklin Templeton Thinks Equity Markets piece, Growth or value? For active managers it can be both. (3) All things considered, the evolving treatment of intangible assets may be one of the most impactful trends in the global economy, making them impossible to ignore.

Below is a summary of the key points address in the full paper: 

- The rise of intangible assets has distorted the difference between value and growth investing. When balance sheets are adjusted for intangibles, “expensive” stocks
could appear to be “value” names. More intangible investments translate to higher, but uncertain, growth. Seemingly expensive companies with low profitability ratios and high intangible-intensity should not be automatically ruled out by true value strategies because, when a company proves the resilience of its business model, multiples can normalize.

- Thinking beyond the label of value and growth is critical. Passive portfolios with factor bets are now extremely vulnerable to changes of style categorization.

- Accounting standards have not kept pace and lead to inconsistent reporting and misclassification. Money spent on activities that create intangible assets is typically expensed, which leads to undercapitalization of intangibles and distorts traditional valuation metrics. This creates a widening valuation disparity between book value and market value. Solid and standardized environment, social and governance (ESG) frameworks will transform the way intangibles are captured on financial statements

- Intangible assets include brand and human capital which reflect how companies treat their people, communities, and the environment. Incorporation of wider
definitions of “quality” that include ESG factors will be critical in the newly emerging investment landscape.

- Further, current accounting practice may disincentivize management to make socially responsible investments, at a risk to environment, society, and the strategic position of their organizations.

- Many intangible-heavy firms will be affected by the ongoing international tax reform, e.g., around half the US tech names pay less than the proposed 15% minimum
global tax.(4)

- With the notable exceptions of South Korea and China, most emerging economies struggle to build strong research and development (R&D) networks. This tendency is unlikely to be reversed and constitutes a barrier to climbing the innovation ladder.

-  Collapsing antitrust enforcement can be seen as a prop for expansion of dominant companies. If successful, intangible investments can strengthen quasi-monopolistic
markets and concentration.

- The role of intangible assets will be enhanced in the future given progressing technological development, globalization, growing market sizes, the increasing role of
labor-intensive services, improving financial development, business friendly regulatory environment, and government support.

<br>

## IMPACTS ON VALUE AND GROWTH EQUITY CLASSIFICATIONS
Current accounting treatment’s failure to capture internally generated intangible assets has an impact on many topical themes. A better understanding of accounting nuances can shed light on the growth versus value debate. To put it simply, if intangibles are more fully considered, migrations of stocks between value and growth happen.

To illustrate our point, we adjusted the price-to-earnings multiple of the index representing growth stocks(5) by adding back our proxy of internally generated intangibles: 100% of R&D and 30% of selling, general and administrative (SG&A) expenses (see Research Methodology in Appendix of full paper). Interestingly, the adjustment makes the valuation of growth stocks look more in line with the standard valuation of the portfolio of value stocks.(6) While this is just preliminary analysis and further research will be needed, it highlights that incorporation of intangibles may significantly alter the current definitions of value and growth.

Active management strategies have been evolving and pure reliance on traditional accounting measures and their mean reverting properties is less common. Investors who require exposure to this traditional definition of value do it via indexing. Leading style indexes provide useful information about the relative performance of traditionally defined value and growth stocks and investment strategies based on such indexes can be profitable if executed nimbly. However, investors should be aware of the inherent limitations before making any investment decision.

<br>

## INTANGIBLES ARE A KEY ISSUE IN ONGOING GLOBAL TAX REFORM
2021 has brought some significant developments to international tax policy. The G7 (Group of Seven), a group of the world’s richest countries, agreed to make big multinational companies like Amazon, Meta Platforms FB and Google pay more tax in the countries where they are selling their products or services. The plan also backs a global minimum tax rate to limit tax competition between countries. Then, 130 OECD countries have also supported the initiative. Intangibles-heavy companies, or at least some of them(7) will undoubtedly be affected if the proposed changes come into effect. 

Intangible-intensity of multinational enterprises is a big part of the ongoing global tax reform. Intangible assets are easy to move around geographically. Hence, big companies can arbitrage differences in tax regimes. Increasingly, income from intangible sources has migrated to low-tax countries, allowing those companies to reduce their effective tax rates. 

<br>

## INTANGIBLE ASSETS ARE OFTEN STRONGLY CONNECTED WITH ESG GOALS

Intangible assets include brand and human capital, which reflect how companies treat their people, communities, and the environment, and how a company achieves its ESG investment goals. The shift towards an era of intellectual property makes the incorporation of relevant ESG factors crucial to the evaluation of a company.

Consumer and institutional investors’ preferences are evolving. The asset management industry needs to respond to this demand. Consequently, the prominence of sustainability-oriented investment has been accelerating over the last decade. In 2020, global sustainable investments reached more than US$35 trillion. Exhibit 12 portrays the growth of sustainable assets in five major regions. Growth has been steady everywhere but in. 

Predictably, growing intangible-intensity correlates with the widening adoption of ESG, as ESG can fill the value creation gap in financial reporting. Increased focus on the formation of intangible assets through ESG investments can improve the informational usefulness of sustainability reports. Further, the ESG value proposition can eventually transform a financial reporting system so that more intangibles are captured in financial statements.

Given the evolving macroeconomic backdrop and long-term investment drivers, companies will be under pressure to change at almost every level. Those that are good corporate citizens are already better placed for the changing consumer and investor preferences. 

The adoption of a wider definition of ‘quality’ that includes ESG factors will be critical in the newly emerging investment landscape.(8) Markets have been adopting socially responsible criteria which have largely benefited investors. However, accounting practices have not kept pace. A more readily implementable and standardized ESG framework is needed to further motivate companies to make responsible strategic decisions and to fill the value creation gap in financial reporting.

###### Endnotes
###### 1. Source: Analysis by Franklin Templeton Investment Institute, Factset. As of 12/31/2020.
###### 2. Source: as of September 2021, Franklin Templeton Investment Institute, Deep water waves.
###### 3. Source: See our paper, “Growth of Value? For active managers it can be both,” November 2021. Chief Market Strategist Stephen Dover is joined by five of our equity teams—each by one of our independent investment managers—offering their views that the traditional growth or value distinction for stocks based on index construction could be misleading, including the role intangibles may play in valuation processes.
###### 4. Source: Analysis by Franklin Templeton Investment Institute, Factset. As of 5/31/2021. The analysis is based on the constituents of the S&P 500 Information Technology Index and their effective tax rates for the last calendar year.
###### 5. Source: The MSCI USA Growth Index. Indexes are unmanaged, and one cannot invest directly in an index. They do not include fees, expenses or sales charges. Important data provider notices and terms available at www.franklintempletondatasources.com.
###### 6. Source: The MSCI USA Value Index. Indexes are unmanaged, and one cannot invest directly in an index. They do not include fees, expenses or sales charges. Important data provider notices and terms available at www.franklintempletondatasources.com.
###### 7. Precise analysis of winners and losers will be possible when the final shape of the deal is known. It may be hard to avoid loopholes. The current OECD framework sets profitability threshold percentage to 10%. For example, Amazon with its business model that depresses profitability ratios (6.3% pre-tax margin in 2020) can be let off the hook.
###### 8. Source: Kim Catechis, Franklin Templeton Investment Institute, Deep Water Waves, August 2021

###### **WHAT ARE THE RISKS?**
###### **All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.** The positioning of a specific portfolio may differ from the information presented herein due to various factors, including, but not limited to, allocations from the core portfolio and specific investment objectives, guidelines, strategy and restrictions of a portfolio. There is no assurance any forecast, projection or estimate will be realized. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors actors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Derivatives, including currency management strategies, involve costs and can create economic leverage in a portfolio which may result in significant volatility and cause the portfolio to participate in losses (as well as enable gains) on an amount that exceeds the portfolio’s initial investment. A strategy may not achieve the anticipated benefits, and may realize losses, when a counterparty fails to perform as promised. Currency rates may fluctuate significantly over short periods of time and can reduce returns. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector—prices of such securities can be volatile, particularly over the short term. Impact investing and/or Environmental, Social and Governance (ESG) managers may take into consideration factors beyond traditional financial information to select securities, which could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. Further, ESG strategies may rely on certain values-based criteria to eliminate exposures found in similar strategies or broad market benchmarks, which could also result in relative investment performance deviating. Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

###### **IMPORTANT LEGAL INFORMATION**
###### This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton. The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as of the publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the fi rm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal. Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verifi ed, validated or audited such data. Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction. Issued in the U.S. by Franklin Distributors, LLC, One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com - Franklin Distributors, LLC, member FINRA/SIPC, is the principal distributor of Franklin Templeton U.S. registered products, which are not FDIC insured; may lose value; and are not bank guaranteed and are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.

Deep Waves: The Quiet Undertow of Intangible Assets

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Climate change: investing for a sustainable tomorrow

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# About the Initative

Let’s Invest Together! (LIT!) is the culmination of significant cross-industry effort, with IMAS’ Gamification workgroup, collaborating with MoneySense, CPF Board, and the SGX Group, to accelerate Optimai, our fintech partner discovered through the IMAS Digital Accelerator Program (DAP). By leveraging on technology, and the mechanics of gamification, we have created a prototype of a fast-moving investment education game, available on iOS and Playstore, readily accessible to the investing public. 


<iframe width="560" height="315" src="https://www.youtube.com/embed/TRBCZukn7yo" title="YouTube video player" frameborder="0" allow="accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture" allowfullscreen></iframe>

Given the evolution of the investor base, many of whom have become more digitally savvy, the IMAS Education Committee saw the opportunity in 2020 to leverage on gaming technology and the IMAS DAP to create a fun and exciting utility to help build investment knowledge amongst the investing community.

Utilising real data to simulate actual events, the game is uniquely able to help investors better understand how the various asset class interact, their risk profile and how their investment decisions can impact their portfolios, thereby improve their ability to asset allocate and build resilient investment portfolio for themselves.

##### Download the game now:

1. [Google Playstore](https://play.google.com/store/apps/details?id=com.Optimai.LetsInvestTogether)
2. [Apple Store](https://apps.apple.com/app/lets-invest-together/id1576667625)

Let's Invest Together! (LIT!)

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Looking at the market today, it's easy to forget where we were at around 15 months ago. Many of the market declines of the past decade or so, including the stock market crash of 2008, are fast becoming faded memories for most of us. But it is the investors who endured these difficult times came out in perhaps the best shape, and as is often the case, those who had the nerve to stay invested were richly rewarded.

And yet, the decision about whether to change your investment strategy or sell a fund is usually not clear-cut, even in hindsight. After the dust has settled on a decision and the investment has performed well or poorly, the “right” answer is wholly dependent on the individual. Selling criteria are not a one-size-fits-all list that fit every investor, but there are some situations when selling is particularly ill-advised. Christine Benz, director of personal finance at Morningstar, picks these three key examples.

**Poor Short-Term Performance**
 
It’s almost never a good idea to sell a fund based on weak performance alone, especially over the short-term. You might have been tempted to sell in last year's market sell-off for example, but we now know the Covid crash was the shortest in history. Instead, if a fund is lagging its peers or an index, your first move should be to investigate why that is. It could be that the manager is simply sticking with an investment strategy that happens to be out of favour, as has been the case with many value-leaning funds in recent years. But weak performance may also be a sign that something more serious is afoot - Morningstar's own research has found that many active funds fail to beat the market over the long-term.

Researching an investment’s fundamentals can be time-consuming, which is why you don't want to get too caught up in investigating short-term bouts of underperformance. Most funds, especially those that are using truly active strategies, will trail their peers at times, often for very good reasons and sometimes for a few years or more (that could be the case with some perfectly solid, defensively positioned funds during a market rally, for example).

Instead, save your energy for checking up on funds when they've underperformed over longer stretches of time or in a period when you would have expected them to perform well. If, for example, you selected a fund because of its low-risk tendencies, but it lost far more than its peers in 2020, that's a legitimate reason to ask whether something about its strategy changed or its risk controls weren’t what you thought they were. And even if the fund isn’t bad, it may not be a good fit in your portfolio.

**Inconsistent Performance**

On a similar vein, investors often get themselves worked up when a fund’s relative returns are inconsistent on a year-to-year basis. Sure, it can be comforting to see a fund land in its category's top half like clockwork—and a small handful of funds has actually managed to generate return rankings that have been remarkably consistent from year to year.

But holding all of your funds to that standard would cause you to kick out some fine offerings that, while not consistent performers on a calendar-year basis, are consistent where it counts: they employ their strategies with discipline and don't waver, even if the market isn't rewarding them in the near term.

It's also important to remember that a calendar year is a fairly short and arbitrary time period, and a fund that has looked erratic over January-December time periods may appear perfectly consistent when measured over a different 12-month time frame—say, from April to March of each year. Investors shouldn't get too hung up on year-to-year performance consistency when deciding what to hold in their portfolios. Looking at annualised returns can be a better way to judge long-term performance, as these smooth out good and bad periods to indicate what average return an investor has received each year. 

**Macroeconomic News**

Macroeconomic news - whether it's the direction of interest rates, rising inflation or GDP growth in China and India - often appears right alongside news about the market's trajectory. And it's true that what's in the headlines has the potential to move the markets up or down on a daily basis, or even over longer time frames. The trouble is that by the time a certain news item makes its way into the headlines, other market participants have already digested it and priced it in.

If you decide to sell your fund based on that news, you're likely to be too late. Instead, a better tack for investors, at least as it relates to their portfolios, is to keep their heads down and focus on factors that they can control: their savings and spending rates, the quality of their investment holdings, and the total costs they pay for those investments. There is much virtue in tuning out the noise when it comes to managing your portfolio.





*©2021 Morningstar. All rights reserved. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided as of the date written, solely for informational purposes; and subject to change at any time without notice. This content is not an offer to buy or sell any particular security and is not warranted to be correct, complete or accurate. Past performance is not a guarantee of future results. The Morningstar name and logo are registered marks of Morningstar, Inc. This article includes proprietary materials of Morningstar; reproduction, transcription or other use, by any means, in whole or in part, without prior, written consent of Morningstar is prohibited. This article is intended for general circulation, and does not take into account the specific investment objectives, financial situation or particular needs of any particular person. Investors should consult a financial adviser regarding the suitability of any investment product, taking into account their specific investment objectives, financial situation or particular needs, before making any investment decisions. Morningstar Investment Management Asia Limited is licensed and regulated by the Hong Kong Securities and Futures Commission to provide investment research and investment advisory services to professional investors only. Morningstar Investment Adviser Singapore Pte. Limited is licensed by the Monetary Authority of Singapore to provide financial advisory services in Singapore. Either Morningstar Investment Management Asia Limited or Morningstar Investment Adviser Singapore Pte. Limited will be the entity responsible for the creation and distribution of the research services described in this article.*

3 Bad Reasons to Sell a Fund

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Last week, we tested a strategy with two [Chinese equity indices](https://sg.morningstar.com/sg/news/211963/does-the-rhyming-%e2%80%9csell-in-may-go-away%e2%80%9d-work.aspx), and talked about how it timing the market makes you lose out on gains over the long-term. The modeling of index returns concluded that botching a market-timing decision does sacrifice a period of (strong) returns. It proved our point – time in the market is better than timing the market.

Tom Lauricella, Editorial Direct for Professional Audience at Morningstar, explains that [ineffective market-timing](https://www.morningstar.com/articles/972119/3-charts-that-show-why-investors-should-stay-the-course-throughout-market-turmoil) efforts can result in a significant opportunity cost and show the effects of missing the one best month on an annual return. “Although successful market-timing may improve portfolio performance, it is very difficult to time the market consistently,” says Lauricella, adding that the long-term gains from US stocks have been demonstrated to offset short-term losses.

Even worse, poor market timing means you give up the chance to gain more from the compounding of reinvested gains, therefore the net effect in an investment strategy is negative when compared to a portfolio that stays the course.

**What is Compounding?**

In a short answer, staying the course is the key to allow the compounding to work out. But what exactly drives compounding. Let’s start with what’s known as the ‘compound interest’ formula:

**End value = Initial value of capital*(1+Rate of change)Time**

1.  Initial Capital determines how much in absolute terms you can gain at a certain rate for a period of time.
2.  Rate of Change or the rate of investment return defines at what pace the initial and reinvested capital is to compound.
3.  Time Horizon defines for how many time periods your assets compound itself.

Put simply, compounding can be explained as the money (or returns) your portfolio earns each year, and then both your initial capital and your returns of previous years earn returns, leading to a point where you have a much larger capital pool. That means, the larger each of the equation’s components (on the right) is, the bigger your total capital would snowball into overtime.

It’s clearer in a side-by-side line graph that plots four scenarios. First, we let the base case (purple line) be a portfolio with a starting capital of $10,000. The portfolio invests in assets at the end of Year 0 that could generate an average of 10% each year and remains the same for the next 35 years.

For each of the remaining three lines, only one variable is adjusted in illustrating the outcome upon a shortened time horizon, a lower rate of return and a smaller capital to start in the equation.

![Elements in compounding.jfif](/uploads/Elements_in_compounding_c94ad1f49c.jfif)


With all else equal, beginning with capital in half means the portfolio will grow at the same rate but arriving at the exact 50% in the end value of the base case.

By contrast, when axing the investment horizon and the rate of return by half, what you afford is a return far less than just half of the base case. Shortening the investment horizon gives up the sessions that the portfolio can compound, while a smaller investment return simply flattens the curve by a large extent. Both result in merely 20% in end value as compared to the base case.

With a view to long-term performance, we go back to the base case of our data simulation and assume that in each calendar an investor adds 10% and 20%, in this case $1,000 and $2,000, to their portfolio (shown as dotted lines).

![Enlarging the compounding effect.jfif](/uploads/Enlarging_the_compounding_effect_64ba5c7108.jfif)


We find that upsizing the total portfolio value on a regular basis takes advantage of the compounding, enabling the portfolios to notch high absolute returns. This is for those who don’t have a large pot of starting investment capital, say at the early stage of their careers. Instead of sitting on cash to save up a sizable amount in some time, it is worth considering starting small to let the compound work. Expanding the capital base can come later by building up a disciplined top-up mechanism to your portfolio.

Indeed, the stock market is seen as a risky investment if you look at it for the short term. Data have shown proof that long-term returns have outsized short-term fluctuations and have triumphed over the risk of missing the one best month on an annual return by betting in and out. In practice, trying to call the trough and the peak of the market prices is distinctly tricky. The strategy involves a great deal of knowledge and luck. For individual investors who lack experience and time in technical research analysis, market timing would then be primarily driven by biases like loss aversion or herd mentality, which may cause some investors to end up buying high and selling low. Staying the course will bear fruit if you endure the time with discipline.

 

 

*©2021 Morningstar. All rights reserved. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided as of the date written, solely for informational purposes; and subject to change at any time without notice. This content is not an offer to buy or sell any particular security and is not warranted to be correct, complete or accurate. Past performance is not a guarantee of future results. The Morningstar name and logo are registered marks of Morningstar, Inc. This article includes proprietary materials of Morningstar; reproduction, transcription or other use, by any means, in whole or in part, without prior, written consent of Morningstar is prohibited. This article is intended for general circulation, and does not take into account the specific investment objectives, financial situation or particular needs of any particular person. Investors should consult a financial adviser regarding the suitability of any investment product, taking into account their specific investment objectives, financial situation or particular needs, before making any investment decisions. Morningstar Investment Management Asia Limited is licensed and regulated by the Hong Kong Securities and Futures Commission to provide investment research and investment advisory services to professional investors only. Morningstar Investment Adviser Singapore Pte. Limited is licensed by the Monetary Authority of Singapore to provide financial advisory services in Singapore. Either Morningstar Investment Management Asia Limited or Morningstar Investment Adviser Singapore Pte. Limited will be the entity responsible for the creation and distribution of the research services described in this article.*

How Your Money Works for You

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Are disruptive technologies the new and improved version of the 1990s dot-com stocks? The short answer is no, but there are certainly some similarities building.

ARK Innovation ETF (ARKK), an icon of thematic investing, is probably the [highest-profile example of investing in disruptive technology](https://www.morningstar.co.uk/uk/news/210997/ark-innovations-thematic-approach-is-ill-prepared-for-a-major-twist.aspx). Even after sliding since its February highs, the stock remains almost double where it traded a year ago and triple from two years ago. Here, you can see how the returns of this single fund compare with the returns of the [Morningstar US Technology Index](https://indexes.morningstar.com/our-indexes/equity/F00000LJ9E) in the era of the dot-com bubble.

![us tech returns and ARK.jpg](/uploads/us_tech_returns_and_ARK_8652ab2ec8.jpg)

While speculative excess in the market has driven many of these stocks far beyond our fair value estimates, there are still several stocks we think are attractive for long-term investors.

## What is Disruptive Technology Anyway?
The term [disruptive technology is wide-ranging](https://www.morningstar.co.uk/uk/news/212269/what-is-thematic-investing.aspx), but the key tenets are that:

• It encompasses situations which are more transformative than evolutionary, and in which it revolutionises the way business activities are conducted.
• In addition to providing economic value to the innovators, disruptive technology can affect an entire economic chain ranging from suppliers to end customers.
• In our view, disruptive technologies are not confined to just the technology industry, but anywhere in the economy that would derive enhanced economic value from innovation.

The 1990s dot-com boom was fueled by singular focus on the advent of the Internet and its possibilities. Many of the Internet stocks were hardly more than a grandiose idea with little in the way of a business proposal--much less a plan to profitability.

Today, instead of being limited to a narrow scope on the Internet, companies focused on disruptive technologies are spread throughout the entire economy and are targeting new ways to revolutionise numerous industries and sectors. While many of these companies are still within their early-stage development and product monetisation, they generally have a greater focus on achieving near-term profitability than the dot-com stocks did.

## Why the Current Focus on Disruptive Technologies?

A lot of it has been driven by the coronavirus pandemic, which hasn’t so much formulated a new way of life as it has accelerated many economic and social trends which were already in place. Our previous series has looked at how to [profit from disruption](https://www.morningstar.co.uk/uk/news/203939/how-to-profit-from-disruption-part-4.aspx). 

For example, shutdowns and social distancing drove rapid acceptance of working from home, online education, and e-commerce. Among other advances, the healthcare community employed big data analysis to model the progression of the virus and utilized new technologies to develop, test, and roll out vaccines in record time.

Consider: Teladoc Health (TDOC) is a virtual health provider that serves patients across all communication mediums; Palantir (PLTR) allows clients to manage and analyze large, disparate data sets; and in support of the work-from-home environment, DocuSign (DOCU) enables users to automate and provide legally binding contracts from any device.

## How Does Morningstar Identify Disruptive Tech?

Morningstar’s equity research analysts review each of their companies to identify those that not only may be a direct developer of key technological advancements, but also those companies that stand to be indirect beneficiaries. Those companies are then reviewed to determine which will derive additional economic earnings growth from heightened revenue growth, greater cost savings, and/or enhanced productivity.

We have broken down disruptive technology’s key themes into nine different classifications:

1. **Big data and analytics**: Capability to utilise artificial intelligence to analyze large, complex and disparate data sets.

2. **Bioinformatics**: Science of collecting and analyzing complex biological data.

3. **Energy & environmental systems**: Wide-ranging field encompassing alternative or renewable energy sources and storage, to pollution control and mitigation.

4. **Financial services**: Broad array of services tied to nontraditional funding, banking, and crypto currencies.

5. **Medicine & neuroscience**: Advancement of new medicines as well as neurochemistry and experimental psychology that deals with the structure or function of the brain and nervous system.

6. **Nanotechnology**: Science that deals with dimensions of less than 100 nanometers, especially manipulation of individual molecules and atoms.

7. **Networks and computer systems**: Increase in connectivity and enhanced productivity.

8. **Robotics**: Design and application of robotics to enhance productivity.

9. **3D printing**: Constructing an object from a three-dimension model by layering successive layers of materials.

Are Disruptive Technologies the Next Dot-com Bubble?

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## **ESG DISCLOSURES: LOOKING BEYOND THE SURFACE**
Sustainable investing is more than about seeking companies with top-notch environmental, social and governance (ESG) profiles.

Across emerging markets, corporate ESG disclosures are uneven, and therein lies the opportunity for investors who look beyond the surface, according to Franklin Templeton Emerging Markets Equity’s Andrew Ness and Preyesh Patel.

Sustainable investing is more than about seeking companies with top-notch environmental, social and governance (ESG) profiles. It is also about uncovering companies that are improving their ESG footprints, and their disclosures go a long way toward signaling and evidencing such progress. Yet, across emerging markets (EMs), corporate ESG disclosures are uneven and broadly lag those in developed markets (DMs).

Investors relying solely on published information to assess EM companies’ sustainability efforts and ambitions risk missing the mark significantly. Therein lies the opportunity for investors who can look beyond the surface. In our decades of investing in EMs, we have developed insights into companies’ sustainability journeys through our local research and longstanding engagement with managements.

We distil three key observations from our analyses and experience:

- EM companies are not entirely behind their DM peers in ESG disclosure. Firms in select EMs have been more transparent. Also encouraging is the increasing openness that EM companies have displayed in recent years. Our local presence is an advantage here as we are often able to establish deeper insights though our relationships with companies.
- Market-wide ESG policies and initiatives are gaining ground in EMs. We expect this trend to boost companies’ ESG disclosures and public accountability. In fact, we have been heavily involved in driving the agenda around policy advocacy.
-  Investors can advocate better disclosures and other improvements through engagement with companies, regulators and other stakeholders. The relationships of trust we have built often give us the leeway to discuss material issues and help shape change.

We believe that some of the most overlooked sustainable investment opportunities in EMs lie in companies making positive ESG transitions. Evolving ESG disclosures—and their impact on investors’ ability to perceive and position for these transitions—will be key to watch.

## A VARIED DISCLOSURE LANDSCAPE
Sustainable investing is often associated with the search for ESG leaders, but that focus can overshadow the investment opportunities that also lie in companies boosting their ESG credentials. This pitfall deserves particular attention in EMs, where a general perception of their ESG gap relative to DMs has kept them off some sustainable investors’ radar. That caution has persisted despite EMs’ growing ESG awareness over the years. To some extent, EM companies’ ESG reporting shortfalls may have held back investor confidence. Using Bloomberg’s ESG disclosure scores as a proxy, we see that EM companies as a whole trailed DM firms in the amount of ESG data that they reported publicly.1 By individual market, however, the picture is a lot more nuanced. Levels of corporate ESG disclosure varied widely across EMs, with select markets such as Malaysia and Brazil faring better than the United States. Markets such as Taiwan and India also scored comparably well. Taking a broad-brush view of EM companies’ disclosure deficit would discount the pockets of strong reporting practices that exist.

What we also find promising is the growing transparency that most EM companies have shown. Over the past few years, corporate ESG disclosure scores rose more for EMs than for Europe and Japan.2 The faster pace of advance for EMs could partly reflect the lower base that they started from, and we think they have room to progress further.

Bright Spots in Emerging Market Corporate Disclosures
Market Average Bloomberg ESG Disclosure Score (0-100)
![templeton esg article.jpg](/uploads/templeton_esg_article_aa62352070.jpg)

Source: Bloomberg. Latest data as of FY2020 (or, if unavailable, FY2019). Proprietary Bloomberg score based on the extent of a company’s ESG disclosure. Companies that are not covered by ESG group will have no score and will show N/A. Companies that do not disclose anything will show a value of ‘0.’ The score ranges from 0.1 for companies that disclose a minimum amount of ESG data to 100 for those that disclose every data point collected by Bloomberg. Each data point is weighted in terms of importance, with data such as Greenhouse Gas Emissions carrying greater weight than other disclosures. A consistent list of topics, data fields, and field weights apply across sectors and regions. This score measures the amount of ESG data a company reports publicly and does not measure the company’s performance on any data point. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. Important data provide notices and terms available at www.franklintempletondatasources.com.

## TOP-DOWN POLICY TAILWINDS
ESG disclosures in EMs have improved along with the introduction of market-wide ESG policies and initiatives. We expect this trend to accelerate as regulators and investors become increasingly ESG-conscious, and especially as interest in sustainable investing grows. Stewardship codes, corporate governance codes and other directives play an influential role in encouraging disclosures.

Several EMs with above-average Bloomberg ESG disclosure scores have continued to strengthen their policies. Taiwan, for example, launched a new three-year corporate governance roadmap for listed companies in 2020. As part of measures to enhance information transparency, more companies would have to issue sustainability reports. With Chinese being the predominant language in Taiwan, our analysts’ local language skills are often pivotal for accessing critical information here.

India began to apply a stewardship code for mutual funds in 2020, urging institutional investors to boost their monitoring of investee companies and engagement with them. This year, policymakers expanded the scope of companies’ business responsibility reports, requiring them to file more quantifiable and granular ESG information.

Meanwhile, certain EMs lagging their peers in ESG disclosures have sought to improve. South Korea’s state pension fund and leading institutional investor National Pension Service adopted a stewardship code in 2018, galvanizing a push for greater corporate accountability in the country. While Korea could benefit from a clearer corporate governance roadmap, it has implemented some long-awaited reforms.

China’s relative weakness in ESG disclosures belies its considerable step-up over the years. Although China does not have a stewardship code, the China Securities Regulatory Commission (CSRC) released a new corporate governance code in 2018. This year, the CSRC revised annual and semiannual reporting rules for domestically listed companies, requiring them to disclose environmental and social responsibility information under a separate section. The new rules are a meaningful signal of positive change, especially in light of China’s carbon neutral pledge and overall elevated emphasis on ESG. In our view, China’s move toward mandatory ESG reporting will also likely improve the quality of disclosures that we see from companies.

## STOCK EXCHANGES PAVE THE WAY FORWARD
Also noteworthy are stock exchange initiatives aimed at boosting listed companies’ ESG practices—and drawing sustainability-focused capital to their markets. Some 93% of EMs have stock exchanges that are members of the Sustainable Stock Exchanges initiative, a United Nations (UN) partnership program that explores how bourses can enhance ESG performance and encourage sustainable investment.3 Some stock exchanges have actively pushed for more ESG disclosures. In the Middle East, where disclosure rates have largely trailed both EMs and DMs, almost all exchanges have communicated the need for companies to incorporate ESG considerations into their business strategies and reporting. Several exchanges have developed ESG reporting guidelines for companies. Some, including Tadawul stock exchange in Saudi Arabia and Boursa Kuwait, have announced plans to launch ESG indexes.

We expect ESG indexes to advance the sustainability agenda considerably. Companies seeking inclusion in such indexes have powerful incentives to meet qualifying ESG criteria and report the relevant metrics and targets. Increased disclosure, in turn, deepens their public accountability on ESG issues and could spur them on to bolster their ESG credentials. Taken together, we think that ESG policies and initiatives have a favorable impact on corporate behaviors.

Backing our belief, we have seen many EM companies display increased shareholder friendliness over the years, often reflected in a greater willingness to repurchase shares or raise dividends. In line with the latter, the overall dividend payout ratio in EMs climbed from 36.2% at end-2017 to 48.6% at end-2020.4 South Korea has been one of the strong improvers on this front, riding on the momentum of policy shifts in the country. Improved corporate behaviors could also manifest in stronger business models and earnings quality, as well as lower ESG risks. Market recognition of all these changes could drive upward valuation re-ratings.

## THE VALUE OF RESEARCH, ENGAGEMENT AND PARTNERSHIP
Recall that ESG disclosures across EMs are uneven. While third-party ESG ratings are available, research agencies differ in their scope and focus of company coverage. Data gaps and subjectivity can also lead to inconsistent ratings.

At times, we have found companies receiving low ESG grades, more due to patchy disclosures than to fundamental problems. We use published information as a starting point for research and incorporate our own findings to form forward-looking views on companies’ ESG prospects. The additional work requires in-depth local studies of individual markets and companies, as well as first-hand access to managements and other stakeholders.

Our engagements go beyond the corporate level. We have frequent discussions with regulators, stock exchanges, corporate governance bodies and other stakeholders in our advocacy of sound capital market policies, which can have a far-reaching impact on economic development, corporate behavior and investor interests. We are also members of select stock exchange committees that discuss ESG and other issues.

We believe that meaningful ESG improvements take time. This makes sustainable investing a lot about identifying companies seeking or making progress on their ESG journeys, just as it is important to spot existing ESG leaders. However, varying levels of ESG disclosures in EMs are likely to keep investors from getting a full view of companies’ ESG direction.

Even amid growing transparency, we still find proprietary on-the-ground research and sustained company engagement vital in discerning businesses’ sustainability commitment and intentions. Our experience investing in EMs has shown us the difference that deep relationships with companies can make. Mutual trust and two-way communications often pave the way for us to partner with them in exploring and shaping improvements in ESG disclosures and other areas. All this work, if done well, could add up to a competitive advantage in spotting ESG advancers before the rest of the market has adequately priced in their prospects.


**ENDNOTES**
1. Source: Bloomberg. Latest data as of FY2020 (or, if unavailable, FY2019). Proprietary Bloomberg score based on the extent of a company’s ESG disclosure. Companies that are not covered by ESG group will have no score and will show N/A. Companies that do not disclose anything will show a value of ‘0.’ The score ranges from 0.1 for companies that disclose a minimum amount of ESG data to 100 for those that disclose every data point collected by Bloomberg. Each data point is weighted in terms of importance, with data such as Greenhouse Gas Emissions carrying greater weight than other disclosures. A consistent list of topics, data fields, and field weights apply across sectors and regions. This score measures the amount of ESG data a company reports publicly and does not measure the company’s performance on any data point. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.

2. Source: Bloomberg. Data based on change from FY2017 to FY2020 (or, if unavailable, FY2019). Proprietary Bloomberg score based on the extent of a company’s ESG disclosure. Companies that are not covered by ESG group will have no score and will show N/A. Companies that do not disclose anything will show a value of ‘0.’ The score ranges from 0.1 for companies that disclose a minimum amount of ESG data to 100 for those that disclose every data point collected by Bloomberg. Each data point is weighted in terms of importance, with data such as Greenhouse Gas Emissions carrying greater weight than other disclosures. A consistent list of topics, data fields, and field weights apply across sectors and regions. This score measures the amount of ESG data a company reports publicly and does not measure the company’s performance on any data point. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges

3. Source: Sustainable Stock Exchanges Initiative (member list cross checked with current list of emerging market countries based on the MSCI EM Index), May 2021.

4. Source: Bloomberg, as of December 2020. Based on MSCI Emerging Markets Index. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.

**What Are the Risks?**

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies; investments in emerging markets involve heightened risks related to the same factors. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.

Impact investing and/or Environmental, Social and Governance (ESG) managers may take into consideration factors beyond traditional financial information to select securities, which could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. Further, ESG strategies may rely on certain values-based criteria to eliminate exposures found in similar strategies or broad market benchmarks, which could also result in relative investment performance deviating.

There is no assurance any estimate, forecast or projection will be realized.

ESG Disclosures: Looking Beyond the Surface

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When the future is uncertain, [diversification is key](link). This has been the mantra of proponents of 60/40 portfolios (60% stocks/40% bonds) commonly known as ‘balanced portfolios', and the bedrock of several strategies adopted both by institutional and individual investors around the world.

But this strategy is not without risk, prompting some investors to question the benefits of this approach.

During the first quarter of 2020, a simple 60/40 portfolio for a US investor had one of the largest drawdowns since the 60s, according to a Goldman Sachs research report. “This followed a decade of very strong risk-adjusted returns for balanced portfolios, supported by a combined bull market in equities and bonds but negative equity/bond correlations,” the report goes.

**Balanced Did Its Job**

Although this typical balanced portfolio had a difficult first quarter in 2020, its returns subsequently improved. And so far this year, the outperformance of equities (on a global basis) has outweighed the poorer returns from bonds.

Performance of 60/40 Portfolio and Correlation of Asset Classes Over Time


![60 40 portfolio.jfif](/uploads/60_40_portfolio_4333852100.jfif)

As Jason Kephart, senior analyst at Morningstar, recently put: “Ironically for the 60/40 doomsayers, those same factors that caused interest rates to spike also spurred strong stock returns that more than outpaced the losses in the bond portfolio.”

This might not come as a complete surprise. In a typical economic recovery, the yield curve tends to steepen, and equity returns usually improve.

**Everything’s Expensive**

Yet the fact that both bond and equity markets are now expensive might puzzle some investors. When valuations are high for both asset classes, prospective returns are low and the risk of drawdown potentially increases. The crash of financial markets last year was a painful illustration.

But this puzzling environment has been around for some time now. Therefore, isn’t there a risk of a higher correlation between bonds and stocks that would undermine a key attraction of a balanced portfolio?

Year after year, the very low interest rate environment created by central banks has forced many investors to increase their risk exposure to find more decent returns. Some even have traded risk for illiquidity and endorsed alternative asset classes such as private equity, real assets (such as infrastructures), higher-yielding asset classes (high yield, emerging debt) or fancier but riskier assets such as cryptocurrencies.

“This temptation to increase exposure to less liquid asset classes to find income and compensate for the lower yield of traditional asset classes is risky,” reminds Clemence Dachicourt, a senior portfolio manager with Morningstar Investment Management Europe. “Over time, bonds have shown they still can play a role in diversifying risk and be a safe haven for portfolios,” she adds.

**Passed the Test**

“The first quarter of 2021 showed that even the worst quarter for U.S. investment-grade bonds in the last 20 years wasn't enough to derail the classic 60/40 portfolio”, says Jason Kephart.

So what’s the take for investors. As long as the correlation between traditional asset classes doesn’t shift dramatically and the portfolio continues to rise over time, then holding a 60/40 portfolio still makes sense.

That doesn’t mean investors shouldn't consider some alternative mixes but perhaps hold those on the margins and keep your core in stocks and bonds. Although, instead of holding broad indexes, they might want to consider diversifying by adding buckets of individual stocks and bonds.

At the end of the day, the most important risk any investor should always think about is the permanent loss of capital and the loss of purchasing power. The 60/40 portfolio still offers the best defence. And even it if did seem to veer off course at one point, it could have been by design.


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