When the UK voted to leave the European Union in June 2016, it had one very obvious and dramatic effect – the drop in the value of sterling. Whatever your view on Brexit or its potential long-term disadvantages and advantages, the immediate impact on investors (sterling’s collapse) was pretty clear.
To some extent, UK investors were insulated from these economic challenges. Weaker sterling pushed up earnings for international companies and helped exporters. More than 70% of FTSE 100 profits are generated outside of the UK and over the past ten years this index has produced an average annual total return of 6.5%.
The FTSE 250 index has also performed particularly well, returning 8.3% over the past ten years on a total return basis. These figures suggest investors have seen real annual returns of 4.7% and 5% per annum respectively.
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But even these figures pale in comparison to the rate of return UK investors would have been able to achieve investing in US stocks. An investment of £1,000 in a low-cost S&P 500 tracker fund would have grown at a compound annual rate of 15.6% over the past ten years thanks to a combination of the stronger US equity market performance and sterling’s devaluation.
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Why am I bringing up this example right now? Because I believe it clearly illustrates why investors need to have some exposure to international markets, regardless of how comfortable they are with their home market. Too much exposure to a home region can bring unnecessary risks – the immediate effect of Brexit being an excellent illustrative example.
The outcome of the referendum was unknowable until the day after it happened. And once the results came through, investors had little or no time to re-position before the pound slid.
We had a similar event earlier this year. In the space of a few days the outlook for European economies deteriorated rapidly overnight when Russia invaded Ukraine. High oil and gas prices are sucking money away from energy importers to exporters (the UK is relatively self-sufficient in this respect with around half of its natural gas consumption coming from the North Sea), causing pain around the world. This only adds weight to the diversification argument.
It does not pay to have all of your eggs in one basket
The aim of international diversification is not necessarily to try and bet which country is going to succeed or fail over the next decade. Trying to predict these sorts of macroeconomic events is almost impossible.
One of the greatest advantages private investors have is the fact that we can invest anywhere in the world, in any opportunity where we believe there’s money to be made. And some countries do things much better than others.
While the UK might be a science and pharmaceutical superpower, America clearly has the edge when it comes to global technology giants. The US market is dominated by technology companies while one of the biggest sectors in the FTSE 100‘s resource stocks. There are also attractive opportunities in Europe in the pharmaceutical sector and luxury goods. Meanwhile, there are far more semiconductor manufacturers listed in Asia than there are in the West.
There is far more to international investing than just trying to pick which countries will succeed or fail over the next five or ten years. It’s really about picking the best companies in the world. If they are part of an economy that happens to outperform the rest of the world, then that’s an added bonus.
If I have to choose between picking the best tech company in the world listed in the US and the second-best in the UK, why would I pick the second best? It does not make any sense.
However, I would caution against international diversification for international diversification’s sake. For example, there’s really no sense in buying Brazilian stocks just because I have too much exposure to North American equities. The most important part is finding the right opportunities.
I personally wouldn’t invest in any South American markets because I’m not comfortable with the level of protection given to international investors, though you may differ. Instead, I focus on finding the best companies in markets I understand, mainly Europe, the UK and North America.
The barriers to entry are always getting lower
The barriers to international investing are no-longer as high as they once were either. Most online stockbrokers now offer international equity dealing for the same price as UK stocks and shares. A few are holding onto antiquated ways of charging over the odds for international deals, but with so much choice on offer, investors don’t need to use these brokers.
And if you’re not comfortable picking stocks in other markets and currencies, there’s always the option of buying an index tracker fund or investment trust with international exposure.
