Mind the Gap

In 2021 we worked through a total of 1 927 companies across the globe. These are largely representative of the global opportunity set and include just about every major listed company in the world. These 1 927 companies have a combined market cap of $78 trillion. For each company, we estimated an expected return, which updates in real-time as prices and underlying fundamentals change. By aggregating this data, we can draw some inferences about what the global stock market looks like today, from a bottom-up perspective.


Generally, investment managers derive their market views from a top-down perspective. In other words, they make macro growth forecasts for entire countries/regions and industries. They then allocate capital accordingly working their way down to the individual businesses. We work from the opposite perspective. Since our aim is to invest in a portfolio of individual businesses, we don’t usually spend much time building views on overall markets. Nevertheless, it can be instructive to examine the results of such analysis and assess prevailing macro conditions.

Developed vs Emerging Markets

One such condition is the valuation gap between developing and emerging markets. Top-down economic analysis suggests that developing markets (the US in particular) have the most favourable economic conditions for investment. However, this ignores the underlying asset valuations, just as it did a little over a decade ago when the macro conditions were the opposite. What is important is not prevailing economic conditions, nor recent returns, but future investment returns. A decade ago, emerging markets had outperformed, conditions looked favourable – but returns have since disappointed because valuations were too high. Today, it would appear, we are seeing the opposite extreme:

Estimated Return is based on Bellwood Capital’s aggregated analysis of long-term return prospects for companies and is not guaranteed.


What is immediately clear is that our expected returns for emerging market assets are much higher than our expected returns for developed markets*. This is consistent with the relative valuations. Our portfolio weights are also tilted towards emerging markets. We also hold a significant amount of cash in lieu of developed market exposure. Remember that we do not target regional exposures based on macro forecasts. We look at individual opportunities and maximize exposure within our risk management framework. The overall weights come out in the wash, so to speak, but it is reassuring to see the consistency.


* This probably understates the gap since we tend to use conservative inputs when assets appear cheap (i.e. they’re competing for a place in our portfolios) and a more optimistic inputs when assets are wildly overvalued.

Valuations drive returns for broad markets

Looking at the above data, one could conclude that our expected returns are simply a function of valuations. This would be overly simplistic because growth rates (and yields) are just as important as valuations. Return = Yield + Growth + Revaluation. When we’re dealing with individual companies a difference in growth rate often outweighs a difference in valuation. But when we aggregate entire regions, differences in long-term growth rates tend to be a lot smaller. Most of the variation in long-term returns is attributable to differences in valuation. This impacts not only revaluation, but also yield. For this reason, the inverse relationship between valuation and expected long-term return for a region tends to be very strong.


It’s also important to note that our exposure within developed markets is not the average of those markets. The United States and Europe are enormous opportunity sets. Even though they are expensive in aggregate, there are still good individual businesses that are priced for high returns by our estimation. We do not allow our macro views to dictate where we invest, nor do we invest in aggregate markets. We invest in diversified portfolios of individual businesses, based on their individual merits, from around the globe.


The valuation gap (and hence the expected return gap) between developed and emerging markets is very high at present. While recent returns and macroeconomic forecasts appear to suggest the superiority of developed markets, it is valuations that will likely drive long-term returns in the future. We are comfortable to maintain our tilt towards emerging markets, while adhering to the limits established in our overall risk management framework.