With one day before 2021 ends, the MSCI UK Index is up 20.2% year to date versus the MSCI World ex. UK’s 24.1%—the UK’s tenth straight year of relative underperformance.[i] The benefits of global diversification may seem fairly self-evident. Yet relative performance—though important—isn’t the only reason we think it is most beneficial for investors seeking long-term growth to spread their portfolio across North America, Europe and Asia as well as Britain. Simply, different countries have different industrial strengths, making it useful, in our view, to shop globally to gain diversification amongst sectors and industries.
To see the influence the concentration of certain sectors in a country’s equity market can have on its returns, we think it is helpful to consider UK stocks’ performance relative to the rest of the developed world since 1995. Exhibit 1 depicts this, with the line rising when the rest of the world is leading the UK and falling when the rest of the world is trailing.
Exhibit 1: Non-UK Stock Returns Relative to the UK’s
Source: FactSet, as of 30/12/2021. MSCI World ex. UK relative to MSCI UK returns with net dividends, November 1995 – November 2021. Indexed to 100 at November 1995.
As the chart demonstrates, the UK lagged in the late-1990s, when America’s big Tech industry was booming. Then, Britain outperformed in 2000 – 2007, during the US’s dot-com collapse and the Energy and Materials-led boom that followed. UK stocks’ subsequent lag over the last several years coincides with a long stretch of Tech- and growth-orientated stock leadership.[ii] (We define growth stocks as featuring greater long-term earnings prospects largely independent from the economic cycle, which leads investors to bid up their share prices relative to their earnings or sales.) Tech is less than 2% of the MSCI UK Index (versus the MSCI World’s 24%), and those in it aren’t very growth-orientated, in our view—focusing on industrial systems, safety equipment and small business.[iii] Therefore, we think getting adequate diversification within the Tech sector requires looking abroad—primarily to the US, and to a lesser extent Asia.[iv]
We think checking under the surface like this shows why looking at sectors globally can be more illuminating than a country or regional perspective alone. Global positioning isn’t just about geographic exposure, in our view, but also the opportunities to diversify in sectors and industries available across the world—such as in Tech and Tech-like names. Tech and similar growth stocks globally have outperformed, for the most part.[v] Just outside the US, their weightings are smaller.[vi] Meanwhile, some nations excel in other areas, including Pharmaceuticals (many are European) and select Machinery firms targeting long-lasting economic trends (e.g., Japanese industrial automation specialists).
Not only that, but we think an important tenet of investing is to always know you could be wrong. In our view, that suggests you should have some exposure to value stocks just in case. (We define value stocks as tending to be economically sensitive with slim profit margins that are reliant on debt financing, often resulting in relatively low multiples of share price to earnings or sales.) The menu of value-orientated companies is bigger in the UK, Europe and Asia, whilst America tends to have a relative advantage in growth-orientated companies.[vii] In our experience, positioning portfolios for what you don’t think is especially likely could help when things don’t go your way. We don’t think it will, but if growth falters and value stocks take up the mantle, getting some broad exposure to value can be a net benefit.
In our view, investing globally provides you more options than focusing on a single country—and opportunity, which we think is invaluable for long-term investors. In our view, that is the essence of global diversification: allowing you to achieve wise portfolio management.
[i] Source: FactSet, as of 30/12/2021. MSCI UK and MSCI World ex. UK returns with net dividends, 31/12/2020 – 29/12/2021.
[ii] Ibid. Statement based on MSCI UK, MSCI World Information Technology and MSCI World Growth returns with net dividends, 31/12/2011 – 29/12/2021.
[iii] Ibid. Tech weighting in MSCI UK and MSCI World Indexes, 29/12/2021.
[iv] Ibid. Statement based on country weightings in the MSCI World Information Technology Index.
[v] Ibid. Statement based on MSCI World Information Technology and MSCI World returns with net dividends, 31/12/2011 – 29/12/2021.
[vi] Ibid. Tech weighting in MSCI USA and MSCI World ex. USA Indexes, 29/12/2021.
[vii] Ibid. Value weighting in MSCI USA and MSCI World ex. USA Indexes, 29/12/2021.
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