The UK has become a far less insular country over the past forty years or so. Our eating habits, for example, have undergone a revolution. Many Britons are as familiar with Indian or Thai dishes as fish and chips. Yet when it comes to investing, we appear to have little appetite for exploring foreign opportunities. So while UK shares accounted for 4.6% of the overall global equity market in 2016, they accounted for around 27% of UK multi-asset portfolios1. These are funds that vary the amount they invest in assets such as shares, bonds or propertydepending on the manager’s view of the outlook for markets.
Going the extra mile in search of diversification
However, research shows that this home bias handicaps the ability of investors to maximise investment returns. Certainly, investors who focus on the domestic market will be far less diversified than those who hold a portfolio of international stocks. This is true even in the UK, even though an estimated 75% of the revenues of FTSE 100 member-companies are earned from abroad. That is because of the heavy concentration of the index in terms of companies and sectors. Just four companies account for 25% of the index, while a few sectors account for over half of the index by value.
Investing internationally, by contrast, gives investors exposure to potentially fast-growing stocks and sectors that are simply lacking in the UK. There are just two technology stocks, for example, in the FTSE 100. Investing overseas allows an investor to harness technologies that are changing the world and could reap vast profits for companies such as Google, Facebook and Tesla. Investing internationally also gives investors exposure to economies with robust growth potential. While the UK economy is expected to grow by around 2% this year, many overseas economies are forecast to expand at a much faster pace.
Currency risk begins at home
Of course, investing globally does bring currency risks. So if you invest in US stocks, for example, the value of your investment will be affected by movements in the pound’s value against the dollar. However, given that around 75% of earnings at the UK’s largest 100 companies by value come from abroad, investors in UK companies are also exposed to considerable currency risk. A sharp rise in sterling means that UK goods are less attractive to overseas buyers, adversely affecting corporate profitability. But surely the sharp depreciation of sterling in 2016, following the vote to leave the European Union in June 2016, would nullify the arguments against home bias? After all, the FTSE 100 rose by 19% in 2016 as the tumbling pound boosted overseas earnings. And yet an internationally-diversified investor would have done much better in 2016 (and most other years since 2010) than one biased towards the home market. US equities, for example, rose by 33% in sterling terms, while European and Japanese stocks both rose by 23%. A UK-based investor would have seen a 34% rise in the value of their emerging market equities3.
So, just as many of us have come to appreciate chicken tikka masala as much as a traditional roast dinner, maybe it is time we also adopted a more adventurous approach in terms of our investing habits.
1 Bloomberg, http://www.businessinsider.com/world-stock-market-capitalizations-2016-11?IR=T; Aviva Investors
2 Citywire, 30 June 2016 http://citywireukinsights.co.uk/2016/06/the-uk-stocks-most-and-least-hit-by-weak-pound/
3 Thomson Reuters, May 2017.