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Investors typically have a “home bias” when it comes to their portfolio. In the UK, the average investor holds around 50% of their equity allocation in British equities. The reasons lie in many factors including familiarity, a fear of foreign currency fluctuations and transaction costs. Yet there are some powerful reasons for diversifying your portfolio across the globe.
Below, our team at Cedar House offers a case for global equity investing in 2021. We hope you find this content useful. If you’d like to find out more or discuss your own financial plan with us, please contact our team for more information or to access personalised financial advice:
020 8366 4400 or firstname.lastname@example.org
The opportunity beyond the UK
Here in the UK, the investment opportunity is considerable. The London Stock Exchange (LSE) is presently valued at around £3.8 trillion, representing the UK’s largest and most successful companies. There is a strong tradition of equity investing in the country, with the LSE founded in 1801 – making it the oldest exchange in the world. However, despite these credentials, the UK only represents about 4.1% of the world’s total market capitalisation. China sits at 5.1%, Japan at 7.4% and the USA at a huge 55.9%.
The LSE, at the time of writing, is heavily concentrated on industries and sectors like consumer goods, industrials and financials. Examples include Tesco, Ferguson and NatWest Group. Some of these companies recovered strongly during the COVID-19 pandemic, although many are still struggling to increase their share price – particularly those in retail, property, travel and leisure. However, the UK equity market is notably light on certain industries and sectors which are found elsewhere in the world. The SAP 500 in the USA, for instance, is notably tech-heavy featuring the likes of Apple, Microsoft, Facebook and Google at the top. By looking outside of their home market, therefore, UK investors can potentially access unique opportunities not readily available in the present domestic equity market.
Suppose 80-100% of your equity portfolio is concentrated here in the UK, and the country met a big economic crisis. The domestic markets plummet whilst others in Japan, the US and Europe fare much better. Even if your equity investments are spread across multiple sectors, by keeping your money in one country there is a risk that your portfolio is over-exposed to a narrower range of economic and market forces. By spreading equity investments across multiple countries as well as many different industries and sectors, however, your portfolio could fare better overall if there is a downturn in any one of them. This is because the higher-performing markets can keep producing strong returns which help off-set any short-term losses in an underperforming one.
The benefits of foreign exchange
Buying shares in UK-based companies is fairly straightforward. You hold British pounds and the business also operates in the same currency. If you want to buy shares in a US-based company, however, then you will need to change your pounds into USD. This means taking the exchange rate into account, which presents a “currency risk” to your investment. Suppose, for instance, a Japan-based fund (dealing in Yen) looks promising, so you buy some shares. Over the next 12 months the fund climbs 20% in value. This looks great to you on paper, yet when you factor in the new exchange rate – e.g. a 20% rise in the value of Yen against the GBP – you are, in real terms, back to where you started.
This may lead you to think that global investing – involving currency exchanges – is a bad idea. Yet the benefits can outweigh the drawbacks. First of all, fluctuations in currency can also work in your favour. Suppose you hold some US-based and Japan-based equity funds, which have had near-stagnant performance sheets over the last 12 months. However, in that same period, the GBP fell in value compared to the USD and Yen. In real terms, therefore, your investments have risen in value. Secondly, even if you focus your portfolio on UK equities, a huge portion of FTSE 100 company revenue comes from foreign operations. To try and smooth revenue streams, many of these businesses seek to hedge away the currency fluctuations involved with these operations. You could argue this means that global equity investing benefits are already reflected in these companies prices and performance. However, focusing on domestic equities means that you hold little/no stake in world-leading companies which are domiciled overseas.
For those who are really worried about the effects of currency fluctuations on their portfolios, do not let that stop you from considering global investing with a financial adviser. Currency-hedged ETFs, for instance, let you invest in overseas stocks and bonds without so much currency risk – albeit at a typically higher price or lower potential rate of return. Bear in mind that investing with foreign currencies tends to amplify both positive and negative returns. In the best-case scenario, your overseas investment rises in value whilst the GBP also rises in international value.
Interested in discussing your financial plan with an experienced financial adviser? Get in touch today to discuss your financial plan with a member of our team here at Cedar House via a free, no-commitment consultation:
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