It is arguable that we can achieve international exposure simply by investing in the FTSE 100 index. This includes many UK-registered companies which operate solely or mainly overseas, such as Antofagasta, Randgold Resources and Xstrata. It also includes many UK companies with substantial non-UK exposure, such as the leading banks, energy and pharmaceutical companies.
However the London market provides only incomplete coverage of the global opportunities, giving, for instance, almost no exposure to information technology and little exposure to industrials (see chart). Even where the market does provide access to the companies quoted on the market in, for example, pharmaceuticals and energy, they may not necessarily be the most attractively-valued companies.
Many people will argue that exposure to overseas equities brings in an additional layer of risk, mainly the currency risk. Traditionally an investor buying a share in a company with a global exposure but quoted in sterling in London is thought to be “safer” than an identical company quoted on, for example, the New York stock exchange in US dollars. This is not necessarily true and it is possible to demonstrate that currency risk is not determined at all by the currency in which the stock is listed, but rather the risk arises entirely from the currencies of assets and operations which the underlying company undertakes.
It is important to distinguish between transactional and translational risk. Transactional risk occurs when the currencies in which costs and revenue are determined are different, but translational risk occurs when operating profits are generated in currencies different from the accounting currency. Studies show that it is the transactional risk that has the most impact on an investment not the translational risk.
So, if we’re going to invest internationally should we look at hedging? Hedging is a way of limiting currency risk but it is a complex and risky operation in its own right and also carries its own costs and is not necessarily the best way of dealing with currency risk.
The reality is that more opportunities exist overseas now than they do in the UK. Irrespective of currency risk we continue to take a multi-asset, geographically-diverse approach to the investment of our portfolios. So where should we be looking for those opportunities? As we move out of the credit crisis of 2009 we are beginning to see a significant de-synchronisation of the global economic recovery. For many years now it has been arguable that diversification has little impact since there has been a high correlation between the performances of major economies in particular. The close correlation is ending and we are seeing sub par growth in those economies where consumers need to re-pay debt and strengthen their balance sheets. Conversely we are seeing growth in those economies where consumer spending is on a firmer footing and where governments are in a better position to stimulate their economy. Emerging markets in general and China in particular typify the latter group.