Diversifying your portfolio by world areas
As a newcomer to the world of investing it can become a bit overwhelming when trying to decide which stocks you should put into your portfolio. Should you be looking at the FTSE 100 (the 100 biggest companies by market capitalisation in the UK) for the big dividends, or should you be looking for the potential ten-baggers in AIM (Alternative Investment Market) for massive growth potential? The truth is that whilst it’s a good idea to position your portfolio with stocks that you understand and have a strong conviction for, what you absolutely do not want to be doing is putting all your eggs in one basket.
If you only invest in small cap tech stocks you might be lucky enough to find the next Apple or Microsoft, but you’ll also be increasing your risk of portfolio losses if there’s a downturn in the small cap technology sector. It’s for this reason that I’ve positioned my own portfolio with as much exposure to global markets as possible, and I’ve done this with a combination of globally focused investment trust and stocks from the FTSE 100.
Investing in the UK isn’t actually investing in the UK
Now you may be thinking that buying stocks in the FTSE 100 is limiting you to exposure to the UK only, but you’d be surprised by how much these huge companies trade worldwide. Approximately 81% of the entire UK market capitalisation comes from the FTSE 100 with around 75% of their earnings coming from overseas. This makes sense if you consider a company like B.P. which has over 97,000 employees worldwide producing a product which is sold throughout the planet.
It, therefore, makes sense that by buying stocks from the largest UK Index you’re also gaining worldwide exposure, but you should also remember that because these companies are trading globally, they can be directly affected by the value of the UK Pound.
If the Pound falls in value then exports from the UK suddenly become cheap to other countries and in turn, they’ll be more likely to buy UK products. However, the downside to this is that anything these companies have to import will also become more expensive, as can be seen in the recent aftermath of the UK decision to leave the E.U.
Avoiding stock overlap
My preferred option in gaining exposure to global markets is to buy funds that invest in specific sectors overseas, and I’ve made every effort to ensure that the holdings within each fund have as little overlap as possible. So, for example, I have exposure to mainly tech stocks traded globally via Scottish Mortgage Investment Trust, as well as some exposure to emerging markets via Murray International Trust.
There’s a wide range of trusts and funds which have exposure to one specific country only, and I initially went down this route by investing in trusts such as Fidelity China Special Situations, which only holds small cap Chinese companies inside its portfolio. This is a great way of profiting from all the upsides that a growing economy has, but for me, there’s too much associated risk if that particular country has a sudden downturn.
It’s up to you how you choose to look at the pros and cons of specific country exposure, but my opinion is that global funds provide plenty of the upside whilst also minimising the downsides in world-wide markets.
One further strategy to gain global exposure is to invest in an ETF which tracks the all-share global index, which attempts to track the economy of the entire worldwide market. We’ll look at ETFs and index-tracking funds in another article.