When it comes to investing, British isn’t always best. To get the most consistent portfolio returns, it’s important to have a spread of investments across multiple regions and locations.
As independent financial planners, one of the tasks we are often asked to perform for new clients is to review their existing investment portfolios and to recommend any necessary changes. In almost all cases, a common theme is for portfolios to have a significant bias towards UK investments, rather than holding a more well-diversified spread of global investments. In recent years, this would often lead to underperformance.
Why is diversification so important?
As most investors are aware, diversification is one of the most important principles of modern investing. And it’s another name for making sure you don’t have all your eggs in one basket. And from a consumer’s point of view, diversification makes sense. After all, most of us don’t only buy UK products at the expense of products from other countries, so why would we limit our investment portfolios to just UK companies?
Even so, most investors still tend to gravitate towards investments in UK companies, or in funds that are weighted towards the UK. While it’s understandable to prefer to invest in the location you know best, no one can know which markets will do well from year to year. By choosing to hold a globally diversified portfolio, investors are giving themselves the best possible chance to capture investment returns wherever they occur, and gain exposure to some of the world’s largest companies.
The need for geographical diversification
A diversified investment strategy is one that aims to ensure your portfolio has the right balance between risk and return. And right now, global diversification is of particular importance for investors.
You don’t need us to tell you that the COVID-19 pandemic has been responsible for the largest and most abrupt shock to global growth in modern times – and the deepest global recession on record. But the timing and the sweeping nature of the pandemic means it has had an uneven – and at times unpredictable – impact on various countries and regions of the world.
While some areas were affected earlier, particularly China and the Far East, and have since by and large recovered, other areas, most notably the US, Europe, and the UK, are still dealing with the crisis. Some countries have emerged relatively unscathed, while others thought they had seen the worst of the pandemic pass, only to experience second (and third) waves. While countries continue to roll out their own vaccination programmes, there continues to be plenty of uncertainty, particularly around the potential for virus variants to continue to spread throughout the world. This uncertainty means volatility will likely remain high as the global economy and markets throughout the world continue to recover from the impact of the pandemic at their own pace.
So, from an investment perspective, the best way to deal with this uncertainty is to spread investments across different regions and within different asset classes. This approach could help to reduce the impact of volatility in specific regions or markets and to help to diversify returns across all areas.
Looking at historic returns over the last decade, it is clear that no single investment region has consistently outperformed others, although research reveals that a diversified portfolio, with allocations to all geographic locations, demonstrates less portfolio volatility than just investing in one or a handful of asset classes or markets.
Size is everything?
Within the UK, investors can hold stakes in household names such as Unilever, AstraZeneca and Royal Dutch Shell, which are familiar to UK investors. However, it is important to remember these companies are tiny compared to the market capitalisation of the largest stocks listed in the US, China and Europe. By way of example, in March 2021, the capitalisation of Apple, the world’s largest company was $2,051bn, closely followed by Microsoft ($1,778bn) and Amazon ($1,558bn). China’s largest companies, Tencent and Alibaba, also rank in the top 10 companies by capitalisation. In stark contrast, the UK’s largest holding by capitalisation was Unilever at just $147bn, leaving it ranking 85th in the world in terms of size.
What is crucial is that those largest global mega-cap stocks, such as Apple and Amazon, have performed well over the course of the pandemic, and their stock price performance has made a significant contribution to the overall recovery seen in global markets since last March. By not holding a suitably diversified global portfolio, and focusing on UK companies, you are limiting your exposure to these potentially strong performing global giants.
Global diversification is key to long-term success
As the past 18 months have shown, life is unpredictable – and so are investment markets. Uncertainties are bound to continue, and it is very difficult to predict how events will play out. This makes it even more important to have a globally diversified investment portfolio that balances out those risks. And, while it’s good to back British businesses and invest in ways that help to support the UK economy, it’s also equally important to make sure your investment portfolio is positioned as well as it can be to deal with the ups and downs or markets, without putting all your eggs in one basket.
If you are interested in discussing your investments with one of our experienced financial planners at FAS, please get in touch here.
This content is for information purposes only. It does not constitute investment advice or financial advice.