Why do investors diversify geographically?

It’s a good idea to spread your portfolio around the world. Rob Morgan explains.

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  1. Rob Morgan

One of the basic principles of investing is diversification. Spreading money across different asset classes – for instance using bonds, property and a little bit in other areas such as infrastructure or gold – can help smooth out returns without compromising overall performance too much.

It’s also a good idea to spread your portfolio around the world. Holding investments from different geographical areas can further spread risk so you don’t have all your eggs in one basket. However, there can be extra risks such as currency exchange movements when investing overseas. When the pound strengthens it can water down returns from overseas assets but when it is weak it can boost values.

Maximise opportunity, reduce risk

A wide geographic approach can also maximise opportunity. No country has all the ‘best’ companies so making sure you have some money invested in all the major areas helps to cover all bases. For instance, here in the UK there is a mature, diverse stock market but it is lacking in certain areas. There aren’t any major tech firms and its biased to areas such as oil and banks, which although arguably decent value do have some headwinds. Big energy firms must contend with a multi-decade trend of decarbonisation, while banks continue to face an era of very low interest rates which makes it more difficult for them to generate profits.

Geographic boundaries mean less these days but having a good global spread can helps ensure your portfolio is diversified. Plus, although different stock markets are often ‘correlated’ with one another (i.e. they tend to move up and down together) they do tend to produce different returns at different times with ‘leadership’ varying from month to month and year to year – as the graphic below shows.

Ranked performance (%) of major investment areas over the past ten calendar years

Source: FE Analytics, total return basis with income reinvested. Based on Investment Association sectors: Asia ex-Japan, North America, Global Emerging Markets, Japan, Europe Ex-UK and UK All Companies.

There are few discernible patterns in the table. If an area is top one year, or fares well for a few years in a row, it does not mean the following year will be strong too. Past performance is not a guide to the future, and it is hard to anticipate where the next ‘best’ returns will come from.

One mistake investors sometimes make is allocating too much to one area and becoming too reliant on its fortunes. Diversification across regions can secure strong long-term returns while avoiding this dependence. Investors often use funds to provide wide-ranging exposure to a geographic area or asset class. Each fund owns dozens of different companies. By holding several funds specialising in various areas it’s possible to build a very diversified portfolio quickly and simply. Alternatively, you can consider a ‘global’ fund that covers all the main areas for you.

A simple route into global stock markets.

One simple and usually low-cost way to invest is through ‘passive’ investments or ‘trackers’. These aim to replicate the performance of a market rather than beat it as an ‘active’ fund would. They do this by owning all or most of the companies that make up that market’s index.

A global equity index tracker offers a spread of holdings from around the world – offering instant access the world’s largest companies. Presently the top ten holdings in a typical global index tracker are:

Apple

Microsoft

Amazon

Facebook

Alphabet

Tesla

Johnson & Johnson

JPMorgan Chase

Visa

Proctor & Gamble

Source: FE Analytics

As you might expect, the largest businesses – and thus the top holdings in the fund – are mostly found in the US, especially in the technology space, so around two thirds of a typical tracker fund is invested there. That’s more than there’s been historically and is largely to do with the considerable returns from the internet and e-commerce giants over the past decade leading them to become larger weights. Although the make-up changes over time the geographic exposure of a global tracker at present can be expected to be around:

USA                     66%

Europe                12%

Japan                   8%

UK                        4%

Canada               3%

Australia             2%

Others                 5%

Source: FE Analytics

Some commentators argue that global indices have become lopsided as a result the recent outperformance of the tech sector. Investors wanting less US or technology exposure may wish to diversify further by buying some other funds alongside. There are some ideas on our Foundation Fundlist for doing so. In particular, global trackers contain little or no exposure to emerging markets such as China. Also, there’s not much in the UK, which as our home market usually ought to be weighted at more than a few percent in portfolios.

Yet for those wanting to focus purely on the world’s largest companies, a tracker fund is a great place to start. ‘Active’ managers often struggle to find an edge when analysing large, global businesses that are so well covered by the investment community.

The primary consideration when selecting a tracker is cost. Using funds with the lowest charging structures can, over the long term especially, translate to higher returns. One option is Fidelity Index World, which has highly competitive charges, while those preferring a stock market listed alternative that can be traded at any point during market hours could consider an Exchange Traded Fund (ETF) such as iShares Core MSCI World UCITS ETF.

New to investing? Find out more here.

Find out more about different types of funds here.

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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