Home / News / CFS looks to emerging markets, small caps as US bull run rages on

With two years of double-digit super returns under its belt, Colonial First State’s investment team is taking a hard look at markets and moving money to areas where they think they’ll make more of it.

Over the last two years, equity markets – particularly in the US – have been responsible for the lion’s share of superannuation returns, rising higher and higher on a smaller and smaller number of stocks.

For Jonathan Armitage, chief investment officer at Colonial First State (CFS), two successive years of double-digit returns largely attributable to the S&P and Nasdaq means it’s time to look beyond them. Accordingly, CFS’ investment team has shifted some money away from global equities and the technology theme and into emerging markets and small caps, where valuations are more attractive.

“While it’s excellent we’ve been able to produce some very good returns for members, if you look over the last 25 years, the average calendar year return of a super fund has been slightly below 7 per cent. With 13.8 per cent for balanced members and 16.6 per cent for growth members this year – and that’s on the back of double-digit returns for those cohorts in 2023 – I think it’s fair to say that people should expect that we see returns closer to the average this year.”

Armitage is less concerned about the valuation differential within emerging markets – India is hot, China is not – than their valuation differential with large cap US equities. In aggregate, they represent “very interesting opportunities”.  

“From an asset allocation perspective we look at emerging markets in aggregate, and any which way you cut it, there are pockets – as there always are – where valuations are higher in certain geographies or sectors, but emerging market valuations relative to developed market valuations, the spread is probably the widest you’ve seen for about 20 years.”

CFS is also adding other, uncorrelated return drivers in the form of private credit, looking outside Australia and towards larger companies which are “much better at dealing with speedbumps in the local and global economies”.

“It’s an area where we’ve been very measured in how we’ve increased our exposure, and we’ll continue to be measured,” Armitage says. “But right now the returns we’re seeing there are very attractive for our members over the next three to five years, and have the potential to act as a hedge to more volatile inflation data and more volatile interest rates.”

Armitage thinks investors are underestimating inflation volatility, which could stem from shifting demographics, the energy transition and labour market disruptions arising from potential changes to immigration policy in the United States.

“In the short term and the longer-term, those things change the dynamics of inflation; for a large part of certainly my investment career, we’ve been operating in a period where globalisation has pushed down the cost of manufacturing, services and transportation. Pretty much across the board you’re seeing a reversal of those forces to varying degrees. That leads to a different macroeconomic environment and a different investing environment.”

If there’s a glimmer of positivity in this, it’s that some of the concerns around the geopolitical outlook might recede, Armitage says.

“There’s a lot of focus on geopolitics, quite rightly. But it’s possible that the things that investors are focussed on – whether it’s conflict, trade tensions – will have a lesser impact on returns this year. It gets a lot of airtime and media focus, but it might be that economic fundamentals will once again be the key determinant of investor returns.”