Expanding opportunities and reducing risk when investing
Posted by: Swindells FP, on June 4, 2015.
Holding investments in many different countries broadens the potential opportunities available to you and can help to reduce the overall risk of your investments.
Global diversification is an important consideration when we construct investment portfolios and last year, like most years, was a good example of why.
Although the UK economy was one of the strongest in the developed world in 2014, the UK stock market returned just 1.2 per cent. The globally-diversified developed world index returned 12.1 per cent .¹
Beware world news headlines
News headlines can paint an inaccurate picture of the effect of world events on stock market returns because they do not provide perspective. Russia and Greece hit the headlines in 2014 and, for different reasons, caused some concerns for investors. Both markets fell in 2014, Russia by 42.5 per cent and Greece by 36.2 per cent.
But neither fall would have made a significant contribution to the overall performance of a globally diversified portfolio, because both markets are relatively small. To give this some perspective, Apple, the world’s most valuable listed company, is worth more than three times Russia and Greece combined.
You might ask which countries should I own? The simple answer is “all of them”, or as many as practically possible. The reason for this is that it is impossible to predict which will do the best over any given period of time.
Who would have predicted, for example, that Denmark would be the best performing developed market over the past 20 years? That market, representing around 0.5 per cent of the world, returned an average of 12.3 per cent per year compared to the developed market average of 7.6 per cent.
The Randomness of Returns
This point is colourfully illustrated in the image below, which we call “The Randomness of Returns.”
Source: MSCI developed markets country indices (net dividends) with at least 25 years of data. MSCI data copyright MSCI 2015, all rights reserved.
The table ranks historical annual stock market performance in GBP for different developed and emerging markets from highest to lowest in each year. Each colour corresponds to a different country and the patchwork dispersion of colours shows no predictable pattern in either the developed or emerging markets.
Diversified strategy reduces the risk
Investors who follow a structured, diversified strategy are therefore more likely to capture the returns wherever they happen to occur in any given year. This diversified strategy also reduces the risk of being too heavily invested in any one country that happens to perform particularly badly in any given year.
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¹ All data sourced from Dimensional’s Matrix Book, 2015, and Dimensional’s returns programme.