Breaking down the barriers

INCREASING numbers of Australians are becoming familiar with the concept of international investment. We can trade on the Internet, with some degree of impunity, on the American and other international stock markets.

In years gone by the performance of international portfolios was largely dependent on the geographic diversification that we implemented. Investment managers would choose a region or country and that effectively would determine the returns that would be received by the portfolio. Has that now changed?

JB Were Funds Management would certainly think so and addresses the issue in its latest newsletter.

While recognising that, in many ways, geography is still a powerful diversifier in international investment portfolios, “greater political and financial stability among the world’s major economic regions and a greater level of interconnectivity thanks to technological developments” are breaking down many of the barriers that geography once presented. As a result of this change, JB Were believes it is increasingly possible to view much of the developed world as one combined region.

JB Were points to evidence of this changing environment, even in our own market. The operations of companies such as BHP-Billiton, NAB, News Corporation and the like are all on a global level. Concurrently, the companies overseas such as Microsoft, Nestlé, GlaxoSmithKline, Samsung all operate internationally, almost seamlessly. If we accept the treatise by JB Were that geographic diversification is less important as a vehicle for spreading the risk in a portfolio of international investments, where else should investors be looking to ensure they are getting the maximum diversification benefits?

JB Were proposes that a powerful source of diversification in an international investment portfolio is global industries. In the chart above there are some interesting findings that can be discerned. In the main section of the chart, vertical bars represent major global industries. The top end of the vertical bar represents the best performing company in that industry. The bottom end of the vertical bar represents the worst performing company in that industry.

In essence the bar shows the industry at its best and worst. The middle block of the bar then represents the average performance of the industry.

So, if you looked at an industry such as information technology, the spread between the top performers and the worst performers is quite stark.

We know that anecdotally from the tech wreck visited on us last year. Looking at the global healthcare sector also reveals a similar variance in performance from the top to the bottom. What these comparisons demonstrate is that the performance range for each industry is quite diverse.

Now look at the small section on the right of the chart. This lone bar shows the performance range of the different countries represented in the MSCI World Index. As you can see in that chart, there is a very small range of performance between the worst performing and best performing country.

The implications for us here in Australia are that, while we may have some strong industries such as banking and finance, there are areas of the world markets that are almost unrepresented in this country. For example, the healthcare sector accounts for 12 per cent of the MSCI Index. In Australia there is almost no dedicated healthcare sector. Likewise, with technology, there is only a limited market here, unlike the rest of the world.

So, as we have said many a time, international investing is all about diversification and accessing industries which we would have no exposure to here in Australia. Every portfolio should have an international exposure. The level of exposure is determined by our risk profile.

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