February 2019

What makes gambling different from investing? If pushed for an answer, we would say that one of the key differences is “diversification.”

In other words, the former is primarily about rolling the dice on one hoped-for outcome, based mainly on chance. The latter, however, involves spreading your money out across many different asset types and classes which you reasonably expect to grow.

Images can sometimes present investing in a way which makes it look like gambling. Many of us are familiar with the hectic scenes of traders shouting and running around on the floors of the stock exchanges, buying and selling manically.

Prudent investing, however, is far removed from this image. Rather than putting all of your money into the fate of one company (such as Facebook or Amazon) and hoping it grows, you minimise your risk by putting your money into many different investments.

This way, if one or even several of your investments fail, your other investments should help carry you through and minimise your losses.

An example of diversification in action

When you look at different countries, you may notice that certain countries seem to be more vulnerable to economic shocks than others. This is partly because, like investors who do not spread out their investments, these countries are putting their “economic eggs” in one basket.

For instance, many countries hinge their economies on an important resource which they can produce and trade – such as oil, or coffee. When these commodities do well, their economies boom. When demand for the commodity falls, however, it can cause a huge deficit.

This is one reason why countries often seek to diversify their economies, so they are not reliant on one particular commodity, product or service in order to grow (e.g. manufacturing). Similarly, a wise investor will recognise that by diversifying their investments, they protect themselves from investment “shocks” whilst continuing to benefit from positive performance from other assets.

For instance, suppose you have two investors. Investor A has an investment portfolio (i.e. a set of investments) comprising 100% stocks (i.e. shares in various companies). Investor B, however, has a portfolio comprising 50% stocks and 50% bonds (we’ll come onto this later).

When the stock market experiences a dip or shock, which investor should fare better throughout the storm? Investor B should lose less money than investor A, because his/her bond investments should continue to deliver an investment return even as his/her stocks decline.

Different asset types

Another analogy sometimes used for diversification is the modern military.

Advanced military nations such as the USA, UK, France and Russia all have a range of defence assets at their disposal including infantry, mechanised vehicles (e.g. tanks), air power, naval units and cyber warfare technology.

These different military “assets” exist not just to counter different threats on the battlefield within a theatre of war. Each asset also exists in order to support the other. For instance, armoured vehicles and airpower assets are used to protect infantry during assaults.

Investing can also be conceived in a somewhat similar way. Just as military assets support one another, investment assets can “cover” and “carry through” other assets which might struggle on their own within particular market contexts. For instance, when your commodity investments are declining in value it might be your stocks which keep your investment portfolio moving forward.

Let’s take a quick look at some important asset classes you can include in your portfolio…

Cash

One of the most familiar types of investments, cash investments, are usually seen as lower risk but also tend to carry a lower investment return.

For instance, up to £85,000 of your cash in recognised UK Building Societies and Banks will be protected by the Financial Services Compensation Scheme.

However, many cash investments deliver a poor investment return due to low interest rates, which are largely eclipsed by inflation.

Shares

Sometimes these are called “equities”, and they refer to the stake(s) you have in one or more companies. For instance, you could invest directly in the shares of one company (which is very high risk). Or, you could put your money into an “investment fund” (e.g. a Unit Trust) together with a range of other investors. This fund would then invest this money into a collection of select companies. This is lower risk, because if one company in the fund declines or fails the others should help to keep the overall value of the fund growing.

Property

Many of us are familiar with the idea of house “flipping” – which involves buying a house and later selling it at a profit (often after a period of household improvements).

However, other lower-risk investment opportunities exist when it comes to property. For instance, you might invest in property funds – which are similar to the “share” funds described above, except in this case the investment money is put into residential or commercial property.

Property can be a great investment, but it does carry risk and you also face the issue of your money not being easily accessible once it is invested into property. If you need the money quickly, you might need to wait a lot longer than you would have otherwise liked.

Bonds

When you need money from the bank you can sometimes get a loan. This involves the bank giving you money provided you pay it back over time, with interest (so they make a profit).

In a similar way, you can “lend” your own money to companies and governments through bonds. So, if you buy a UK government bond you are effectively loaning money to them.

The idea is that, over time, you get the principle back as well as interest payments. These investments are generally seen as lower risk (particularly UK government bonds because they have a reputation for paying people back). However, the more reliable the bond-issuer the lower the investment return tends to be, because the risk is lower.

Bonds are usually a vital part of an investment portfolio, because they provide a solid investment foundation and “buffer” in the event that your other investments fall in value.

There are many different funds available to the mindful investor, each offering their own respective pros and cons. Some are better than others.

The difficulty is, it can all get a bit confusing if you aren’t familiar with the terrain. One example is global equity investing. What is it, and how does it help your portfolio?

In this article, we’ll be defining what global equity investing is and why we feel it’s important to consider this when constructing investment portfolios.

Global equity investing: an overview

To get one part of the definition out of the way, “equities” is a term often used for “stocks” which are shares in a company that are typically traded on the stock market.

You can invest in equities (or stocks) individually, by picking a specific company and buying one or more of its shares. This might be a UK-based company, in which case you would be buying a domestic equity.

The other common, less-risky route is to invest in equity funds. This is where you pool your money with other investors into a collection of companies. If the companies are based in the UK, then the fund can fairly be described as a domestic / UK equity fund.

If the fund comprises of businesses which are based abroad, however, then the fund is no longer domestic and might take on another name. For instance, if the companies are based in Western Europe then the fund’s name might be “Western Europe Equity fund”.

Accordingly, a fund comprising businesses from developing countries might be termed a “developing world equities fund”. It might even pick other companies to join the fund, provided they are companies which are based in what is commonly-accepted as “the developing world.”

This is where global equity investing starts to come to the fore. Global equity investing is where you include investments in businesses from outside the UK into your portfolio. As such, a global equity investment fund therefore can pick businesses from across the world.

What’s the value of global equity investing?

The main benefit of a global equity investment fund is that it is not limited to the domestic or regional market when it comes to asset selection. Instead, it can pick the most attractive markets – and stocks – from across the world and include them.

As many people know, certain regions or parts of the world excel in particular sectors of the market. Switzerland, for instance, has a strong reputation for banking and drugs manufacturing. Australia is renowned for its mining businesses. The UK, USA and Israel are making a name for themselves in cyber security, and parts of Asia are excellent for technology.

The manager of a global equity investment fund can survey the world’s markets and pick the strongest companies from the strongest sectors. In addition, fund managers can identify the sectors of the global economy which historically perform better at certain times of year, and tailor their fund planning/strategy accordingly.

The downsides

As always when it comes to investing, it is important to consider the risks as well as the positives when looking at global equity investing.

One risk to factor is currency fluctuations. For instance, a strong pound against foreign currencies (e.g. the dollar or yen) will result in lower international stock values when these are converting into pounds.

Another risk is the potentially higher volatility (i.e. swings up and down) experienced by certain international stock markets. China and Venezuela, for instance, have often shown themselves to be more volatile markets than Germany or France.

Balancing global equity investments

Many people can get nervous about global equity investing, particularly due to “home bias”. This refers to investors’ natural tendency to invest in stocks from their home country, even when faced with strong evidence that diversifying abroad would bring great benefit.

An important balance needs to be achieved by the wise investor. On the one hand, you do not want to take needless, excessive risk when investing in overseas markets and businesses. On the other hand, you do not want to miss out on some great potential returns that are often hard to achieve elsewhere.

When it comes to discerning how to integrate global equities into your investment portfolio, this is where we come in. As experienced Financial Planners we can identify the risks and opportunities, as well as having the resources and means available to construct a solid investment strategy for you.

In 2014, Vanguard delivered some fascinating research. It showed that in 2013, nearly 50% of the global equity market resided in the United States. Yet at the same time, mutual fund managers in the U.S. held only 27% of their equity allocation in funds not domiciled in the U.S.

Certainly this illustrates the subject of “home bias” quite nicely. Yet it also brings an important issue to the fore. Investors who concentrate their investments in their domestic market (e.g. the U.S. or UK) are arguably taking a big risk, because they are subjecting all of their equities to domestic economic and market forces.

If that domestic economy declines or even crashes, then all of the equities in that investment portfolio are exposed. If, however, an appropriate amount of global equities are incorporated into the mix, then these equities will likely not be as affected.

Indeed, the Vanguard research cited earlier even suggests that adding a prudent amount of global equities can reduce the volatility of an investment portfolio. That said, this is not an objective fact and all investment portfolios are different. Indeed, two investment portfolios will likely perform differently within the same time period, even with a similar percentage of global equities comprising the mix.