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Going global through diversification

By: Bill Blevins

Email: [email protected]

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 geography – spreading your investments over different countries and international areas.

Historically, most investors approach international investing through 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.

For example, if you want to aim for higher returns and are prepared to take more risk, you would increase the percentage you hold in emerging markets. If you are very risk conscious, you may drop the more speculative funds altogether.

This system continues to work well and achieve good results, but today we have a different type of international fund for investors to consider as well – a ‘global fund’ or ‘world equity fund’.

These funds have been designed to provide investors with access to specialist strategies and skills which extract value from global equity markets. Managers of these funds aim to identify the companies that will perform best in each industry (sector), irrespective of where the company 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.

The rising trend of globalisation

In the past, most companies limited their activities to a single country. More recently, more and more companies have begun to operate in many different regions. This is a result of improved technology and transportation, as well as the lowering of international trade barriers.

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 US, but it generates over 80 per cent of its revenue from outside the US.

Although they operate around the world, companies like Coca Cola are included in the index of one country. Coca Cola is listed in the US and its share price is therefore partly driven by local US market sentiment. However its earnings are influenced by all the various factors that affect soft drink sales in the 200 countries in which it operates.

HSBC is another good example. In the UK it is approximately 4.9 per cent of the FTSE All Share Index, yet 75 per cent of its earnings come from outside the UK.

As a result of this globalisation, over the last 10 years or so, the factors driving individual stock returns have changed in relative importance. Sectors 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 and so on) but less so for locally focused industries such as retailing.

Global managers

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 difficult and more challenging than looking at a single market. Global managers also need to be sensitive to currency and local market sentiment issues.

If you buy a global fund, therefore, it is important to find one with managers who are experienced in this field, who can span the markets effectively and add value on a consistent basis. 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 from that of regional managers. For example, if a manager of a world equity fund wants to overweight the consumer durables sector in his fund, 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 mid-cap Hong Kong listed company that makes shoes for companies like Nike and has strong performance. In contrast, the manager of a UK equity fund is more limited in the choice of available securities, with just a few companies like JJB Sports at his disposition.

Global or regional?

It is not a case of one being better than another. Both have their attractions.

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. Regional funds also allow for a more modular approach, which means it can be tailored to an individual investor’s needs. 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 investment portfolio to equities, you could consider investing in a world equity fund. However in most cases an international 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.

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