Since the 2016 Brexit referendum, the pound as well as the FTSE 100 and FTSE 250 have been volatile. Daily gyrations have, in effect, become a proxy for the confidence (or lack of it) of investors in the UK economy’s ability to function successfully outside the European Union (EU).
Our economy contracted by 0.2% in the second quarter of the year. Predictions for the three months to the end of September are also rather mixed. If we have a general election soon, we can expect even more volatility.
For those investors who may feel overwhelmed by the effect of fluctuations in the pound or domestic shares in the short run, looking beyond our borders may offer a way to diversify their portfolios and put their mind more at ease.
Global ETFs help decrease the home bias
It is a part of human nature to favour the familiar over what might feel unfamiliar. We tend to connect familiarity with low risk.
Therefore most investors allocate a large portion of their investments in their home countries rather than internationally, as they feel more comfortable with buying shares in domestic companies.
It is not surprising that most British investors remain overly disposed to UK-based investments. In investing lingo, this exposure would be the ‘equity home bias’.
Yet the UK accounts for about 3.5% of the world economy. In other words, there is a whole investing world out there.
One way to increase foreign exposure would be to invest directly in high-quality foreign shares.
But if you are new to investing or do not have the time to select individual companies internationally, then exchange-traded funds (ETFs) or tracker funds could be the way forward. Both are passive investments that track a particular index without attempting to outperform it.
For those investors, I think an ETF to consider could be the FTSE All-World UCITS ETF, tracking the performance of a large number of stocks worldwide.
I regularly get asked about how to invest in the Chinese economic growth story. There are several China ETFs listed on the London Stock Exchange, such as the HSBC MSCI China A Inclusion UCITS ETF or Franklin FTSE China UCITS ETF.
International dividends
As one of the highest-yielding markets in the world, the FTSE 100 currently has a generous dividend yield of about 4.5%.
Yet investing in overseas shares does not mean you have to forego a robust dividend yield or settle for less. Nowadays investors can easily choose specialist active or passive funds that offer robust dividends too.
Several options would include the iShares MSCI World Quality Dividend UCITS ETF, SPDR S&P Euro Dividend Aristocrats UCITS ETF, iShares Asia/Pacific Dividend ETF, and SPDR S&P US Dividend Aristocrats UCITS ETF.
Foolish takeaway
For most investors, diversification of risk is central to investing. Greater international exposure could help reduce the home bias risk significantly without affecting expected total return.
However, it would be extremely difficult to generalise what the the optimal mix between British and foreign shares should be. Also, a comfortable split for one investor may not be the right allocation for another.
Those investors who are not sure whether globally-focused ETFs or tracker funds are appropriate for their portfolios may want to consult a registered financial advisor before investing.
You may also want to double-check the rules for holding foreign funds and ETF in an ISA.