While the FTSE 100‘s performance is sometimes used as a proxy for the wider UK economy, in reality it acts as a poor indicator. That’s because a number of the stocks listed on the FTSE 100 have very little to do with the UK economy, with the index having numerous mining companies, healthcare stocks, oil producers and consumer plays that mostly operate outside the UK.
Furthermore, the FTSE 100 lacks choice in a number of sectors. For example, there are only a handful of technology companies of any considerable size, there are no car manufacturers, few defence companies and almost no entertainment plays in which to invest your hard-earned cash.
As such, it can make sense to look abroad in order to invest in sectors that are simply unavailable on the FTSE 100. For example, the US has a plethora of technology companies and entertainment stocks, while Germany has multiple car manufacturers and Japan offers numerous electrical manufacturers. As a result, investing abroad can help to diversify your portfolio between different sectors, rather than being focused on banks, insurance companies, miners and house builders, which (in terms of their number) dominate the UK index.
Foreign Exchange
Of course, when investing abroad you accept an additional, major risk that buying domestically listed shares does not entail: currency risk. This can clearly work for or against you, but if you can be sensible about where you invest (and when) then you can turn it to your advantage.
For example, at the present time, the US dollar is likely to appreciate versus Sterling. That’s because the US is set to increase interest rates later this year and, while some of this movement may already be priced in, it is unlikely to be fully priced in at the present time. Furthermore, comments from members of the Federal Reserve have indicated that a ‘fast rise’ in rates could be on the cards, which would strengthen the US dollar even further.
Similarly, the Euro is likely to weaken versus Sterling over the medium term. That’s due to the effects of quantitative easing in Europe and also the likelihood of a rate rise in the UK prior to the Eurozone starting to tighten its monetary policy.
Ease Of Purchase
Prior to the internet-age, buying shares in foreign countries was tough. However, nowadays there is very little difference between buying shares listed on the FTSE 100, and shares listed on the NYSE. Certainly, you may need to fill out some additional paperwork before you commence purchasing US shares, for example, (in order to potentially reduce the 30% withholding tax rate) but in terms of costs and simplicity of trading, there are no great hurdles to stop you diversifying your portfolio by region.
Looking Ahead
Of course, it could be argued that global stock markets are highly correlated and that there is very little point in buying international shares. In other words, their performance is roughly the same due to increasing globalisation and the fact that companies listed in the UK operate internationally anyway.
However, that point is simply inaccurate. For example, the FTSE 100 has risen by 29% in the last five years, which is a solid performance. However the DAX (German stock market) has risen by 50% in the same time period, while the S&P 500 (US main market) has soared by 88% during the same time period. As such, it seems obvious for Foolish investors to invest at least a portion of their portfolio outside of these shores.