How to choose a diversified global equity fund

It’s almost a case of better the devil you know, but you only have to look at what has happened to UK equities in the past decade or so to immediately question the premise as Brexit, political turmoil and a lack of exposure to sectors like technology - which have driven growth – have seen UK equities flounder in comparison to their global peers.

As of writing, UK equities now look extremely interesting from a valuation perspective, but tell that to someone who has invested in the region for the past decade. In that time the FTSE 100 has returned 72 per cent, by contrast, US and global equities have returned 315 and 213 per cent respectively*.

The rationale for wider diversification is clear—domestic equities tend to be more exposed to the narrower economic and market forces of their home market, while stocks outside an investor’s home market tend to offer exposure to a wider array of opportunities. Essentially divide and conquer – as we seldom see every region and sector fall at the same time.

With more than 41,000 stocks listed on stock exchanges worldwide** – investing in global equities can be daunting given the excessive choice – but this level of diversification can bring additional volatility control and boost/smooth expected returns. Figures from Vanguard show that in the 50 years between 1970 and 2020, the volatility in returns from global equities was lower than in any other market – the study found that other countries had volatilities that were 15 to 100 per cent greater than the global market index***. 

There are a number of things investors must look at to find these diversified returns. One of the first things you have to consider is the allocation any global fund has to US equities. The MSCI World Index, which captures large and mid-cap representation across 23 developed markets has just shy of 70 per cent allocated to the US****. This in itself is not something to worry about, but simply be aware of. The US is the world’s largest market, meaning significant exposure in global funds does not necessarily mean a huge allocation to a number of the tech behemoths, like Amazon and Google, which have dominated returns in the past decade but sit across the majority of portfolios..

Many truly active managers will not pay any attention to the benchmark and will simply invest where they find the best opportunities, regardless of where a company is listed. At times this could mean an even larger weighting to the US, or indeed being significantly overweight or underweight other countries. If the manager picks the right companies – the fund will perform regardless of how markets are doing.

The narrower exposure to a domestic market also hampers exposure from a sector perspective – we’ve talked about UK investors missing out on stellar returns from tech companies in the US. But you can also miss out on Europe’s market leading luxury or healthcare companies or raw materials in emerging markets.

Another consideration is the ability to hedge away currency fluctuations through a global portfolio. Although this can help smooth revenue streams, foreign exchange can be a diversifier for an investor’s portfolio.

Two further points I’d make are the need for some allocation to emerging markets. Clearly volatility is greater in these countries, but they have also delivered higher average returns. A lack of correlation to developed markets makes a small allocation through a number of countries an attractive proposition. The final point is income – simply put the UK is the leader in this space, but it is heavily dependent on a handful of leading players for dividend yield. Going global offers greater diversification but also, crucially, the potential for greater income growth from countries where company dividend payments are less mature.

Those wanting global equities exposure may want to consider a style agnostic vehicle like Fidelity Global Special Situations, a portfolio of around 100-150 holdings, which is unlikely to have large country or sector bets but has excellent long-term performance. I also like the conservative style of the JOHCM Global Opportunities fund, which focuses on capital preservation and can hold up to 20 per cent in cash if manager Ben Leyland feels there are simply not enough opportunities in the market. A couple of high conviction portfolios investors may also want to consider include Lazard Global Equity Franchise or the Brown Advisory Global Leaders fund.

*Source: FE Analytics, returns in pounds sterling, figures from 19 October 2012 to 20 October 2022

**Source: Fidelity.com

***Source: Vanguard - Global Equity Investing: The benefits of diversification and sizing your allocation

****Source: MSCI AC World Index – figures to 30 September 2022