Investors know the mantra: diversification makes sense. Do not put all your eggs in one basket.
It is excellent advice – even though no one buys baskets of eggs any more, the example works.
When it comes to investment diversification, another idiom also comes to mind: always make sure to look under the bonnet, as what you find may not be what you were expecting.
Let us look at global equity investing for example.
There are lots of ways to invest globally.
The MSCI World index includes more than 1,600 companies.
This sounds sensible; you are investing in shares all over the world, how much more diversified can you get?
However, when you look a little closer you can find that names can be misleading.
The MSCI World index only covers developed markets. Only 23 countries are represented, out of 195 in existence.
The index contains no Chinese, Indian, Brazilian, South African or any other emerging market companies at all.
The global index that does include emerging markets is the less snappily titled MSCI ACWI (All-Countries World Index). So, is this the basket you want?
The devil is in the detail
While the MSCI ACWI covers a great deal of the world economy, it still does not include every single country (despite its name).
Many of the 195 nations do not have investable markets, but it does contain 50 of the biggest, including China and India as well as Egypt, Pakistan and Qatar, among others.
So, the emerging markets are represented, but this is not as much as you might expect.
If you want to invest globally, common sense suggests that you allocate your investments roughly according to size.
The US is the largest economy in the world, making up one quarter of global GDP – so would need a decent chunk of your investment.
China and Europe (excluding the UK) are each around one sixth of the total. Their allocations should probably be a bit smaller than the US, but still substantial.
When you take a closer look under the bonnet of the MSCI ACWI though, you find that the coverage is quite different to what common sense might suggest.
More than 55 per cent of the index is invested in US companies – more than twice its share of the global economy.
European companies are around 12 per cent of the index, compared to nearly 20 per cent of global GDP.
- Diversification is important in investments
- The MSCI ACWI does not cover every country
- One should allocate investments in proportion to the economic world
The biggest difference is China. The second largest economy in the world makes up just 4 per cent of company weight in the ‘All-Countries World’ index.
In this index you are hugely focussed on the US with little exposure in other parts of the world that are doing well, such as China.
US President Donald Trump might like the sound of this portfolio, but is it what you expected? And more importantly, is it sensible?
Home is not always where the heart is
The other area we would encourage investors to examine closer is not just where a company is based, but where it does business.