Diversification Regular investment insights from John Cotter, Vice President at Barclays Stockbrokers. In this edition, John discusses Diversification
Cotter's Corner - Diversification

Diversification

Don't put all your eggs in one basket' is good advice in many situations in life but in the world of investment it probably ranks as number one in my 'golden rules to follow', says John Cotter.

Published 28 June 2009

The process of spreading your investments is referred to as diversification, and this in itself comes in many shapes and sizes. In its most basic form this concept applies to your asset allocation and the need to achieve the correct balance of investment across the four main asset classes; cash, bonds, shares and property. This balance should be dictated by your personal circumstances (age/risk appetite/income requirements etc.) as well of course as market conditions and valuations. After this fundamental question has been addressed perhaps the most important balance to achieve relates to the geographical spread and balance of your portfolio.

It has always been regarded as sensible for the UK-based investor to include some international exposure in his or her portfolio but perhaps never more so than at present when most commentators feel that the UK economy will not be amongst the world leaders in the coming years and therefore you may feel that a more significant proportion of your portfolio should be invested overseas. This view is confirmed by our own house research which you will find by logging into the website, under the heading of Barclays Wealth Insight on the Research tab. Here you will find Signpost (quarterly publication) and Compass (monthly) which review the financial markets and recommend strategies.

At present our analysts model portfolio would be "overweight" in Asia excluding Japan. As you will see from the June edition of Compass, this is based on the view that this region, and other emerging markets, will benefit more from the growth momentum in China and the ongoing financial stimulus from the other major economies. Whether you agree with this particular standpoint is for you to decide but the wisdom of achieving some geographical diversification in your portfolio cannot be questioned.

The good news is that it has never been easier for a UK client to invest overseas. Although it is possible to invest directly in overseas companies it can be more expensive to do so and to achieve diversity in each market takes a lot of money. In addition there is foreign currency risk to consider and the fact these companies can be more difficult to research. This means that there can be better alternatives to consider. In this article I will summarise the main options highlighting their strengths and weaknesses. These investments fall into four broad categories - trackers, protected, managed and leveraged investments. Let me take each in turn.

 

Trackers

The cheapest and most effective trackers available on the market are Exchange Traded Funds (ETFs) with iShares the largest and most well-known of this type of investment. One of the reasons people use them is to achieve immediate access to overseas markets. They are cheap with total expenses ratios averaging just 0.5%, narrow bid / offer spreads and no Stamp Duty levied on purchases. I have already covered details of these investments in a previous Corner and therefore I won't repeat myself here. ETFs trade like a share and because of this and their lower charges they can be more suited for investors taking a shorter term investment view than managed funds would be.

If again you agree with the view referred to above in "Compass" and you want to add to your investment in Asia excluding Japan you could consider an ETF, for example iShares MSCI AC Far East ex-Japan.

 

In this context the main advantages of ETFs are they are relatively cheap, offering immediate access to, and exit from, foreign markets. The disadvantage, which is also one of their main benefits, is that they are simple trackers so if you think it is more of a ‘stock pickers market’ you may prefer the professional management of Unit Trusts and Open Ended Investment Companies (‘OEICS’).

 

Protection

Tradable structured products are a relatively new development worthy of serious consideration. Each note varies in the terms it offers but basically they are trackers that offer a mix of gearing, protection and tradability. In this context the ‘protection’ can be total or partial, the latter only protecting losses to a set level. Also any protection given is only as effective as the protector, in this case Barclays bank plc.

We offer structured products issued by Barclays Bank and which are available through Barclays Stockbrokers. In the primary market they are exclusively offered by Barclays Stockbrokers, but once they are listed, they trade like any other listed instrument with a bid and offer price influenced by the prevailing market conditions.

There are currently 28 Notes quoted on the LSE and available to be traded online. For clients wanting to invest overseas, existing Notes offer exposure to the US, China, Europe (excluding and including the UK), and Japan.

One of the advantages of these Notes is that they offer a level of protection (some partial, some total) that may allow a lower risk investor to feel comfortable investing in foreign markets which they may normally shy away from. They also normally provide gearing that the higher risk investor may find attractive. It all depends on the terms of each Note. The main disadvantage is the loss of the dividend so it’s very much the case of looking at the terms of each Note and evaluating the pros and cons before making an investment decision. Remember structured products may not be suitable for you. It is important that you understand their nature and risk prior to investing as their values can fall as well as rise and if sold before maturity you may get back less than you invested.

 
 

Managed

Here we are talking about unit trusts and OEICS. These are collective investments which are managed by professionals. They provide instant diversification as they are ‘one investment that invests in many’ but they can also allow easy access to overseas markets. Generally speaking the fund manager works to a specific investment objective, often within specific geographical boundaries.

And so if you decide you want to increase your exposure to China and you want to use managed funds to achieve this aim our funds search function can help you narrow down your selection.

Finding the fund factsheet search
1) Select funds, then funds research from the left hand menu on the Products tab
2) From the sub menu select ‘Funds factsheets’
3) On the funds factsheets search options select Funds Market & from the IMA sector drop down - "Asia Pacific excluding Japan".
 

At the time of writing, 51 funds meet these criteria which you could access at discounted prices through our funds market. As you will see there are six that are specifically focussed on China managed by Baring, Gartmore, HSBC, Invesco, Neptune and Jupiter. By clicking on the fund you can access full research on each fund which includes past performance, cost, fund holdings sector breakdown etc.

The main advantages of funds in this context are they can provide access to overseas markets, instant diversification and professional management. The disadvantages are cost and delayed dealing (funds deal on a forward basis so a deal placed in the afternoon won't be dealt until about noon the next working day).

If managed funds appeal as the method by which you want to include or add overseas investment to your portfolio then try to find time to watch the funds seminar.

 
 

Leveraged

For the more experienced investor leveraged investments are available to provide international exposure. Financial Spread Trading and Contracts for Difference allow you to profit from both upward and downward movements of overseas markets. On overseas indices they can offer you gearing of up to 20 times so in effect £5,000 can give you an exposure of £100,000. This naturally provides you with very effective use of your capital but they are vehicles that are only suitable for investors with the highest risk profile.

Although they present an opportunity to make significant profits, the geared nature of CFDs and spread trading means that a relatively small movement in price of the underlying security will result in a much larger movement in the value of your investment. It is possible to quickly lose more money than your initial deposit.
 

Leveraged alternatives are offered via covered warrants and Turbos. The advantage here is that any loss is limited to your original stake. The former achieves this because it is effectively an "option for difference" which you would not exercise if it moved against you, the latter because it has a built in guaranteed stop loss.

Before trading you should fully understand the nature of covered warrants and/or Turbos and the extent of their exposure to risk.

Overseas diversity has always been an important element in successful portfolios and probably never more so than at present. Many people feel the international nature of our companies and indices is sufficient to provide this and although this undoubtedly helps, I believe in our global economy you need to add a more specific focus in areas you find attractive.

 
Good luck with your investing!

Page last updated: 26 June 2008 

Barclays offers wealth and investment management products and services to its clients through Barclays Bank PLC and its subsidiary companies. Barclays Stockbrokers is a trading name of Barclays Bank PLC (Registered No. 1026167 Registered VAT No. 243 8522 62) which is a member of the London Stock Exchange and ISDX. Barclays Bank PLC is registered in England and authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The registered address is 1 Churchill Place, London E14 5HP.

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