Diversification of investment doesn’t have to mean just spreading your money across a number of asset classes. Geographical diversification can also be a really important tool to reduce the risk in your portfolio of investments. Here’s why.

Why spread your risk globally?

In the same way that asset classes don’t all move as one, investments spread across a range of countries can also be expected to perform differently, at different points in time.

While one country might be encountering headwinds, another could be flourishing.

This has been evident in the way that inflation has spread across the world. While many economies have had similar issues, and their central banks have responded similarly, the experience has not been uniform. Japan has historically battled deflation and for the Bank of Japan, its concern now is keeping inflation as high as its target – as others battle to bring it down.

Geopolitical risks are also felt unevenly – as we saw when the conflict in Ukraine first broke out.

Many New Zealand investors are heavily skewed towards their home market – even if it is just because their job, business or house are all in New Zealand. Spreading investments into other economies can help to soften the potential impact of a local downturn that affects New Zealand jobs, business and property investments.

One way to determine how much allocation should go to overseas markets is to consider each country’s global market capitalisation weight.

The United States’ equities are just under 60% of the world equity market. The Euro area is just under 10%, Japan about 6%, and Australia about 2[AM1] [S2] %.

You can then consider an allocation below this starting point based on your sensitivity to a number of considerations, including volatility reduction, implementation costs, taxes, regulation, and your own preferences.

Diversification is about more than just investing in multinational corporations based in other countries. If you invest in companies domiciled in a range of other countries, it provides a wider range of exposure, to different economies and currencies.

Emerging vs emerged markets

Emerging markets can provide investment opportunities, particularly for those seeking growth investments. As Morningstar notes, according to IMF data, the 24 countries making up the MSCI Emerging Market Index today combined to 13.4% of global nominal GDP in 1988. That number grew to 35.7% by the end of 2022. Over the past 10 years, emerging markets were responsible for 53.3% of the world’s nominal GDP growth.

On the other hand, investing into established, large markets such as the US can give investors from countries like New Zealand access to companies that are on a different scale from those listed locally.

Currency hedging

As part of international investment, you may also need to consider your currency hedging strategy. Currency movements can be a way to add significantly to your investment returns and be a diversification strategy. But swings in the value of currency can also be a risk and it is important to have a clear plan around how these should be handled. Your adviser can help you work out the role of currency hedging in your investment portfolio and options available through various fund managers in the market.

Like to talk?

If it is time to discuss your investment portfolio, and the role that diversification plays within it, get in touch with us. As your advisers, we can help you to determine the right investment strategy for your goals and personal circumstances – and to manage your risk.

Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion and seek independent guidance.