Although diversifying away from the UK market can help an investor reduce risk in their portfolio - as well as increase exposure to some exciting growth stories - many investors remain wary of taking the plunge. Chris Salih explores the pros and cons of investing internationally
When it comes to their portfolios, many UK investors prefer to stick firmly to the home-grown. The UK market is diverse, mature and easily understood, so why take the risks of investing elsewhere?
Foreign markets can be volatile and lack diversity, while investors expose themselves to currency risk into the bargain. Add in the vagaries of foreign politics and it is easy to see why many UK investors have kept international equities to a minimum in their portfolios. Is there any reason to reconsider that view?
The advantages of looking abroad should not be underestimated. Diversifying away from the home market can help reduce risk in a portfolio. The UK market tends to be solid and defensive with few pockets of genuine growth. International markets can offer those opportunities. For example, those who have maintained a UK bias over the past three years would have missed out on a return of 57.9% from the average Europe ex UK fund, 60.7% from Asia Pacific ex-Japan or 99.9% from Global Emerging Markets. Of course, they would also have avoided disastrous performance in the US, but it shows that selective exposure to international markets can be rewarding.
Jeremy Podger, manager of the Threadneedle Global Select Growth Fund, believes international investing has a dual purpose, he says: "Its not just about enhancing performance, it also about making sure all your eggs aren't in the same basket. It will be to the benefit of the active international investor, as they will find more opportunities across markets and will have better returns by a few percentage points each year."
Although mature markets (UK, US, Europe) are increasingly correlated, international inv-esting can still improve a portfolio's diversification. Matthew Merritt, head of Strategy at Insight Investment says: "The argument for investing in international equities is becoming much more powerful because although the UK market is reasonable correlated to the rest of the world, the Asian and Emerging Markets not only offer very good returns, but far greater diversification for investors as a whole."
But how much should investors be holding in international equities? After all, the UK currently makes up only about 10% of the global investment universe. Bambos Hambi, head of multi-manager at Gartmore, believes the active managed sector serves as a good guide, because it invests globally, but with a UK bias. He says: "I believe about 55% of equity exposure should remain in the UK, with the other 45% in overseas markets. Of that 45%, 15% should be in Europe, 10% in the US, 8% in Japan, 8% in the Far East ex-Japan and 4% in emerging markets."
Credit Suisse Asset Management (CSAM) recently launched its much publicised Incubator Fund into the active managed sector; the fund is a non-Ucits retail scheme (NURS) and focuses on funds with less than £100m in assets, offering access to funds that are not easily available to private investors. The new fund has 52.8% invested in international equities and Robert Burdett, joint head of CSAM's Multi-Manager Services, believes this represents the peak of its international exposure. He says: "We are definitely towards the higher end in terms of international exposure as we are about 7%-8% down on UK equities at the moment."
Merritt says that although a UK bias does exist, UK investors are generally quite open to international investing. He says: "The UK investor is much more internationally exposed than their US and European counterpart. Around 20%-25% of an average UK portfolio is geared to overseas investments, some may have even more. The US investor has been around the 6% mark, but there have been attempts to raise that to 10%-12%."
While most managers will say that to ensure diversification, an investor needs to be in as many markets as possible, there are certain markets which currently look more attractive. After some time in the investing doldrums, mainland Europe is attracting increasing optimism, with strong corporate results and the euro's recent decline against the dollar helping bolster exporting in the region.
Hambi believes that Europe and Japan are the strongest markets at the moment, he says: "They offer the best options in terms of risk and return. The story for both is restructuring. There are big opportunities for active managers who are shareholder friendly. Improvements have also been made in corporate governance, particularly in Japan where companies are now run much more on a shareholder basis, as opposed to being run for families."
Pacific Asia-ex Japan has also shown strong returns, China can now lay claim to being the engine of world growth, while Korea, Hong Kong and India are also producing strong, consistent returns.
Podger thinks much of the Pacific market is influenced by China and says: "India is somewhat overlooked, it is a broad and deep market and the GDP growth there is extremely good, but that growth is shrouded by China. The Hong Kong economy, by contrast, benefits strongly from the success of China; its economy is in the relatively early signs of an upturn."
Robert Wilson, director of UK multi-manager services at Axa, agrees with Podger. He says: "As the US and UK markets are relatively mature, opportunities are harder to come across. The Far East and Japan are ideal places for diversification offering investors the opportunities to invest across markets."
But what of the risks that come with investing internationally? Currency is a recurrent issue. Podger says: "Currency can be a problem. Since the end of 2001 Sterling has strengthened and returns from international markets can be dull when strengthening like this is taking place."
Hambi believes that currency can also be a benefit, "In the period 1980-1985, as a sterling investor in the US market you would have doubled your assets. Why? Because in 1980 the pound to dollar rate was $2.40 and at the start of 1985 they were trading at parity."
However Hambi feels there are undoubtedly a few hurdles: "There are reasons to stay away from international markets. Less transparency, corporate governance and companies run for families are all apparent in foreign markets. There is also a lack of understanding, heightened risk and the volatility of currency in certain areas."
What then is the outlook for the future? Is international investment likely to rise? Podger says: "Without doubt the UK investor is becoming increasingly international in their outlook. It may simply be a case of raising awareness of the global market for some investors. Rather than looking at the negatives of the international markets, they must be made aware of the benefits."
Hambi adds: "We have improved. We have become much more global as investors realise it is sometimes cheaper overseas. I've visited places like South Africa and Hong Kong, and they are definitely changing. They are now 21st Century cities and their business facilities reflect that. You have a growing middle-class in China now who want cars and houses, and other nations like India are also growing and attracting interest."
The likelihood of a bias to the UK market disappearing is unlikely, but investors are now starting to appreciate the opportunities presented by overseas investment. Currency, volatility and lack of information remain risks, but investment in these markets can help diversify a portfolio. In careful hands, international equities can provide a welcome boost.
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