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The Case for 'CASSH'

PERSPECTIVES: Canada, Australia, Singapore, Switzerland, and Hong Kong could present an investment opportunity for those willing to overweight a basket of the smaller, developed nations

From time to time, Morningstar publishes articles from third party contributors under our "Perspectives" banner. Here, Russ Koesterich, managing director and chief investment strategist at iShares, the world's largest ETF provider, highlights potential investment opportunities for those willing to overweight Canada, Australia, Singapore, Switzerland and Hong Kong. If you are interested in Morningstar featuring your content, please find further details here.

Executive Summary
There is a growing consensus among investors that developed markets are stuck in a slow growth regime, defined by excessive debt, structural deficits, high unemployment, and deteriorating demographics. This is certainly true for Europe and Japan, and arguably for the United States as well.

However, not all developed markets fit into this slow growth purgatory. This narrative ignores significant differences in economic fundamentals. Interestingly, it is the smaller, developed countries that appear most healthy. Many of these countries are less burdened by debt and structural deficits and, for the most part, enjoy better growth prospects. Specifically, we would argue that Canada, Australia, Singapore, Switzerland, and Hong Kong--or CASSH--appear fundamentally stronger than most of the large, developed countries.

While better growth prospects and lower debt are no guarantees of higher returns, at the very least strong fundamentals do suggest that these markets should trade at higher multiples to their larger counterparts. This view is further supported by the fact that most of the smaller, developed countries also contain corporate sectors that are, on average, at least as profitable as those in the United States, Europe, and Japan. Despite these advantages, we do not believe that these fundamentals are fully reflected in the equity prices in these countries. This suggests that there may be an investment opportunity for those investors willing to overweight a basket of the smaller, developed nations.

An overweight to smaller, developed markets may also be justified on the basis of their currencies. Imbalances in many of the larger, developed countries may ultimately manifest in long-term depreciation of the dollar, euro, and yen. For the most part, we believe that countries like Canada and Singapore in particular are well situated to benefit from this trend, and can provide additional diversification for investors.

Small, but Solvent
While some are by nature explorers and seek out the exotic, most of us prefer the familiar. This same bias also informs our investment decisions. Regardless of where an investor lives, the vast majority, either consciously or unconsciously, adopts a home-country bias, i.e., a permanent overweight to one’s home country.

However, investing internationally makes sense for a range of reasons. Including additional countries and regions in a portfolio can create more diversification, help reduce risk and boost returns over the long term. Our bias may be toward our home country, but it should be global. Of course that still begs the question of where to focus one’s attention and find the areas that represent the best opportunity. In last month’s Market Perspectives ("Are Emerging Markets the New Defensives?"), we took a look at emerging markets. In this issue, we focus on the developed world.

With more markets to follow than time to follow them, we all tend to focus on the larger investment opportunities. As a result, assets that represent a smaller portion of an investment universe are often given less attention. We believe that this dynamic is playing out today in equity markets. Investors may be paying insufficient attention to the smaller, developed countries, which exist mostly outside of the dollar, euro, and yen blocks.

Over the past year, investor attention has correctly been drawn to a host of structural problems in developed markets. From fiscal profligacy to deteriorating demographics, the developed world seems to be mired in a prolonged period of slow growth, if not an outright secular decline. However, while we share many of these concerns, it is probably too broad of a brush to use to paint all developed markets. In particular, many of the smaller countries actually look quite different--at least when it comes to deficits, debt, and growth--from the larger countries that most investors consider when thinking about developed markets.

In an effort to highlight some of the opportunities in these smaller, developed markets, we sifted through the MSCI World Index to identify those countries whose fundamentals--particularly as they apply to economic growth--are sufficiently different from their larger counterparts to merit investor focus. In order to keep the list to a manageable level, we applied a somewhat arbitrary cut-off. The countries listed in Chart 1 all represent at least 1% of global market capitalization. This screen was meant to ensure that it was practical to invest in these markets. Next, we looked for markets that were not denominated in dollars, euros, or yen (we made an exception for Hong Kong, whose currency is linked to the dollar). Finally, we eliminated any countries with large fiscal deficits or debt (this is why the United Kingdom did not make the cut). The resulting list included: Canada, Australia, Singapore, Switzerland, and Hong Kong. For the sake of brevity, and at the risk of introducing yet another acronym into the financial lexicon, we have dubbed these the CASSH countries.

This article was originally published on Morningstar.com. Click to continue to the additional pages there: Page 2, 3, 4, 5, 6, 7, 8.

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