Morningstar - Q3 2024 - 52

Investors
When I was at this conference in 2007, I remember
telling the crowd, you look back and you see
double-digit returns for foreign equities: Don't
believe that. That's unsustainable. Now when you
look back and you see international having
produced low-single-digit returns: Don't believe
that either. I feel really good about the future.
Benz: David, you hedge your portfolio's currency
exposure opportunistically. How are you positioning
your portfolio's currency exposures?
Herro: We look at fundamental currency value, like
purchasing power parity, to come up with an
idea on what a currency should be priced at based
on long-term fundamentals. Now, having said that,
it is very inexact-but there is a tendency for
currencies to drift towards their purchasing power
parity level. If it's more than 20% overvalued, we'll
start hedging some of that currency back.
And as it approaches fair value, we're unhedged.
I told you 2014 was a year when the dollar kind
of troughed. At that time, people were saying, the
dollar's lost its reserve status, the dollar's never
going to go up. The euro was probably at $1.50. In
2011, the yen was sitting at 75 yen to the dollar.
Today, we're at 160. But when these levels are at
extremes, people think it's going to last forever. So,
our view is to hedge when currencies are really
expensive-a couple of standard deviations
expensive-and hold the currency when they're
undervalued. When it does swing back-think of
a pendulum-you'll enjoy that currency lift.
Lefkovitz: Rajiv, how does currency figure into your
investment calculus?
Jain: We incorporate that on a bottom-up level in
terms of what the earnings stream would look like
based on the inflation in different countries,
because we feel we don't really add much value
hedging. Been there, tried that, lost enough money,
so we stopped. If inflation, for example, in a
country is 8% and it is 3% in the US, the long-run
currency probably will reflect that. We incorporate
that into the earnings stream.
Benz: The correlations between US and non-US
equities have gone up and up. But emerging markets
look much better from that standpoint; their correlation
relative to US equities is lower. Rajiv, what are your
thoughts on emerging markets to diversify a portfolio?
52
Morningstar Q3 2024
A lot of countries are much more
fiscally responsible, so there's a lot less risk
on a long-term basis.
Rajiv Jain
Jain: Emerging markets are beginning to diverge
more from the US Fed policy. Two years ago,
if somebody asked, US rates are going to go from
basically zero to 5%, what will be the impact
on emerging markets? Nobody would have said
that some of the currencies would actually
appreciate, and interest rates in some cases would
actually be cut. A lot of countries are much
more fiscally responsible, so there's a lot less risk
on a long-term basis.
If you look at the market cap of emerging markets,
now it's larger than non-US developed. It's around
$22 trillion. India has an almost $5 trillion market
cap. Germany's around half of that. The market
caps have shifted. These are large systems on their
own, walking to their own beat. We still
have to find good names; we don't invest based
on diversification from a correlation perspective.
But the opportunity set is increased.
Lefkovitz: When you look at GDP versus equity market
capitalization, the US is way out of whack. David, do
you think that will come into closer proportion?
Herro: I think the price of the asset should
match the productive prowess of the asset. The US
weight in the global all-cap index is now
around 70%, while the US is 25% of global GDP.
Morningstar - Q3 2024

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