Our total equity exposure is currently a bit above our long-term expected average, reflecting our view that a number of headwinds have cleared.
Over the past few years, our equity exposure has trended below our average level, but we made a deliberate change during the second half of 2020, increasing our equity exposure to current levels. This rise comes on the heels of a COVID-driven strategy low point early last year, and has resulted in our systematic market risk (risk emanating from equity beta) rising to the highest level since the first quarter of 2015.
Fading Geopolitical Headwinds
In the Why stage of our investment process, we analyze macro influences that typically do not impact long-term fundamental value but can impact short-term risk and movements in price.
During the past several quarters, we have discussed at length a few of these influences—U.S. protectionist policies (including the trade war, tariffs, and economic sanctions), the opaqueness of Chinese growth, and Brexit negotiations. We have accounted for these developments through macro themes and geopolitical game theaters.
Additionally, in the past 12 months we have been forced to navigate a global pandemic and the massive economic disruption it caused, as well as an energy price shock on the back of failed negotiations between key oil producers.
All of these influences have acted as headwinds for markets and currencies in our universe, either negatively impacting price or risk, or both. And because of these headwinds, we have been particularly cautious in respect of systematic market risk in our portfolios.
A number of headwinds are blowing less powerfully today than they were 6 to 12 months ago.
But we now believe that these influences are fading in terms of their impact. Not every adverse influence has disappeared, but a number of headwinds are blowing less powerfully today than they were 6 to 12 months ago.
In fact, we have recently neutralized our two macro themes focused on U.S. protectionism and Chinese growth. This reduction in short-term headwinds gives us more confidence in raising our systematic market risk level.
Markets Fundamentally Attractive
In addition to the clearing of macro headwinds, we find many equity markets to be undervalued. The fundamental attractiveness is not uniform at a country or sector level right now as there have been significant relative price movements during the past few quarters.
In our view, much of the reason for this divergence in price is the macro influences identified in our Why stage of our investment process mentioned previously.
The increase in systematic market risk in our portfolios has mostly been in those markets that have underperformed and that we happen to find most fundamentally attractive.
The United Kingdom, Singapore, China, Chile, and Australia are good examples of countries that we find to be undervalued. In the first half of 2020, U.K. and Singapore equities became the most undervalued they have been since our arrival at William Blair in 2011. At the same time, the Chinese equity market was the cheapest our analysis has seen in quite a few years, and Australia equities ended March 2020 at a peak level of attractiveness (value greater than price).
The increase in our portfolios’ exposure in these markets brings the exposure at least in line with the fundamental value signal, the one slight outlier being the United Kingdom where our exposure remains greater than what valuation alone would suggest.
Thomas Clarke, partner, is a portfolio manager on William Blair’s Dynamic Allocation Strategies team.