One of the basic rules of successful investing is diversification. International investment is a well-established concept in investment management and most investors appreciate the opportunities
One of the basic rules of successful investing is diversification. International investment is a well-established concept in investment management and most investors appreciate the opportunities for increased sources of return and risk management through diversification.
Key areas of diversification within an asset class (equities, bonds, property) are sectors, currencies, styles, managers and last but certainly not least, geography ? spreading your investments over different countries and regions. This has become more important over recent years as we have seen many emerging markets suffer less from the financial crisis than western ones. The growing middle classes and infrastructure expansion in developing countries can also present an investment opportunity.
Historically, most investors approach international investing through regional ?building blocks?, i.e. investing in different funds to achieve global diversification. Buying such funds, each one focused on one region, allows investors to benefit from the managers? deep local market knowledge.
This ?building block? system continues to work well, but over recent years investors have been benefiting from an alternative method of international investing: global funds.
These funds have been designed to provide investors with access to specialist strategies and skills which extract value from global equity markets. Managers aim to identify the companies that will perform best in each industry (sector), irrespective of where it is based.
The benefit of this wider opportunity set is that with increased globalisation, a company?s competitors are likely to be scattered across continents and not just in a local market. With a global mandate, managers can look at industries in their entirety and compare companies to their competitors, wherever they may be. They can take advantage of cross-border mis-pricings.
The rising trend of globalisation
Nowadays many companies operate in many different regions. This is a result of improved technology and transportation, the lowering of international trade barriers and increased demand from developing nations.
Many companies? profits are now heavily influenced by overseas operations. Let?s take Coca Cola as an example. It is listed and headquartered in the United States but it operates in 200 countries and generates around 75% of its revenue from overseas. Likewise Microsoft receives around two thirds of its revenue from abroad.
HSBC is another good example. It is listed in the UK and makes up around 8% of the FTSE 100, but the majority of its earnings come from outside the UK. In 2010 40% of its revenue came from outside the Europe and the US, with 27% from Asia and 13% from Latin America.
As a result of this globalisation, over the last 15 years or so the factors driving individual stock returns have changed in relative importance. Sector effects have become more influential and country effects less so. A company?s position in its global industry is now as important, if not more important, than in its position in its local country. This is particularly relevant for industries like automobiles and resources (oil, gold, steel etc) but less so for locally focused industries such as retailing.
Such global integration presents investors with an exciting opportunity. However these markets are complex – accounting standards and market practice are not consistent across countries so comparing companies can be challenging. Global managers also need to be sensitive to currency and local market sentiment issues.
If you buy a global fund, therefore, you want the managers to be experienced in this field. The fund should be offered by a reputable investment firm, one with extensive manager research capabilities and which has been reviewing the managers in this field for some time.
A global manager?s approach needs to differ to that of regional managers. For example, if a manager of a world equity fund wants to overweight the consumer durables sector, he can invest in any publicly listed company in the world, including behemoths like Nike and Adidas. He can also look to companies like Yue Yuen, a Hong Kong listed company that makes shoes for companies like Nike. In contrast, the manager of a UK equity fund is more limited in the choice of available securities.
Global or regional?
It is not a case of one being better than another.
A UK fund manager, for example, will know the UK market better than a global manager and so may be able to find less well known companies to help boost returns. On the other hand, a global manager will benefit from his ability to invest in the best companies in the world.
If you only wish to allocate a small portion of your portfolio to equities, you could consider investing in a world equity fund. However in most cases a global fund can be a valuable complement to a strategy using regional funds. In other words, an investor may benefit from a combination of global and regional funds in their equity portfolio.
As always, your portfolio should be based specifically around your objectives, circumstances and risk tolerance and you should discuss your situation with a wealth management firm like Blevins Franks.
By Bill Blevins, Managing Director, Blevins Franks
28th April 2011