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.
Key Points
- 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.
Just because BP has its headquarters in London that does not mean it only sells oil in Britain. Apple might be American, but iPhones are a global phenomenon.
One way to look at this is to breakdown the sales exposure of the companies in the MSCI ACWI. Where do they actually make their money?
This will show us the amount of sales that the companies listed in a country make from their home market.
Some equity markets, such as the UK, are very global, whereas others such as China or Japan are far more domestic.
The UK has lots of global companies listed there for the London postcode. Some have little or nothing to do with the UK economy. In fact, only 20 per cent of the sales of UK-listed businesses actually come from this country.
With China, the opposite is true. More than 88 per cent of Chinese company sales are in mainland China. With 1.2bn potential buyers, perhaps that is no surprise.
European companies are evenly split, with half of sales internal. Meanwhile the US story is very similar to China, with 75 per cent of company sales inside its borders.
Breaking the ACWI down in this way – by sales rather than country of listing – can help balance things out a little.
Europe accounts for almost the same share of global sales as it does of the global economy, and China becomes a little bit better represented, rising to 9 per cent of the total exposure.
However, even when taking this approach, the US still dominates. If you have a lot of US companies, you will have a lot of US exposure. Even on a sales basis, the US is still 50 per cent of the portfolio – double its share of the global economy.
Deliberately different
What this shows is that it is not enough to just have your eggs in different baskets. The financial world is not always as sensible as the egg-carrying world.
We believe that to achieve true diversification, you need to dare to be different. You should allocate investments in proportions closer to the economic world, rather than the way the financial world portrays it.
Ben Kumar is investment strategist at 7IM
