Beyond Bulls & Bears

Diversification at the Core

Pinning down the origin of the saying, “don’t put all your eggs in one basket” is surprisingly difficult. Some say it’s an ancient Chinese proverb. Some attribute it to American author Mark Twain, or Spanish writer Miguel de Cervantes. It’s a simple saying, one you might expect to find cross-stitched onto a pillow, but don’t let its ubiquity fool you: there’s wisdom in those words.

The late Sir John Templeton was certainly a champion of diversifying one’s “basket” of investments. And so is Tucker Scott, portfolio manager for Templeton Global Equity Group. Diversification is at the core of his investment strategy. A summary of his recent remarks: 

Tucker Scott
  • We try to find stocks that we believe are undervalued, then build a portfolio that’s well-diversified by industry and by country
  • We try to limit position sizes in an attempt to help limit potential stock-specific risk
  • We don’t look to an index as a guide to desired weightings; we rely primarily on internal research
  • The primary area where we’ve been purchasing stocks in Europe is the financial sector
  • The core European countries appear to be in a healthy state; we think the European “project” should continue

In this age of global investing, many of the world’s markets are becoming increasingly interconnected, and many companies are becoming more multinational. For example, Detroit-based automakers have moved some of their vehicle production to Asia while at the same time, Asian-based auto suppliers are shifting some manufacturing to the U.S.1 Even emerging market brands are penetrating the developed world. Given this blurring of borders, how does one achieve true global diversification? Scott’s approach:

“Basically, what we’re trying to do is find those stocks around the globe that we believe are undervalued, and then build a portfolio that’s well-diversified by industry and by country. We also try to limit our position sizes: typically we will not purchase additional shares of any stock in which we already have a 5% or higher position size in the portfolio. That can help limit potential stock-specific risk.

We are invested in stocks around the world and in multiple industry groups, so we feel we are well-diversified. We don’t look to an index necessarily as a guide for what kind of weightings we would want to have. Instead we use our own internal research, to identify stocks—no matter which industry or country—that we think are undervalued in order to maintain that well-diversified portfolio.

And in terms of the interconnectedness of the world today, we simply want to have the widest opportunity set possible when we go about looking for opportunities. We think that is a very important piece of the diversification process: that we are able to find those stocks that we believe are undervalued by not excluding certain industries or countries in our approach.” 

Core European Countries Appear to be in “a Healthy State”

While spreading out across the globe is an important aspect of Scott’s approach, so too is finding eggs hiding in places others aren’t looking. He’s finding some of these in Europe, where he feels some stocks are undervalued versus their North American peers.  

“We are really focusing our investment in the core European countries: the UK, France, Germany, Switzerland, Netherlands… and less so in the southern European markets. The primary area where we have been purchasing stocks in Europe is in the financial sector, which of course has been the epicenter of a lot of the fears that we’ve been reading about for the last six to eight months. We are aware that Greece has real problems and could leave the euro. Maybe, to a lesser extent, there are others—perhaps Portugal—that could also at some point leave. However, we think those are survivable potential developments and that the core European countries appear to be in a healthy state right now. We think that the European ‘project’ (that, is, the eurozone) will continue and that the chance of some kind of disruption there appears low in our view.

That said, Scott believes there may be some attractive opportunities in Europe for global bargain hunters like him. He cites the UK banking sector as one possibility.

“We are seeing valuations that in many cases we have only seen during the Great Depression or, in some cases, like in the 1970s when the economic situation was in worse shape than it is today…. So we think it’s a rare opportunity to buy European stocks with such attractive valuations in the current environment. 

As Sir John Templeton said: ‘The time to buy is when the most people are the most fearful.’And I think we are in that neighborhood now.”

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What are the Risks?

All investments involve risks, including the possible loss of principal. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size and lesser liquidity. Diversification does not guarantee a profit or protect against a loss. The fund may also experience greater volatility than a fund that is more broadly diversified geographically.

1Source: U.S. Department of Commerce, International Trade Administration. “On the Road: U.S. Automotive Parts Industry Annual Assessment,” 2011.

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