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Why global index trackers need closer inspection

Jonathon Curtis looks at how investing in global index tracker funds might not offer as much diversification as you’d expect.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

Global index tracker funds are a popular choice for investors.

Much of the appeal lies in their low-cost, ‘one-stop-shop’ approach to investing. Rather than a fund manager researching businesses across the world and selecting those they think have the best potential, global tracker funds simply back the lot.

That adds up to several thousand companies. So surely that offers plenty of diversification?

Not necessarily.

Diversification isn’t just about quantity. It’s about making sure you’re not too exposed to any single area. That way, if a region, sector or style doesn’t do well, it shouldn’t have a disastrous impact on your overall portfolio.

And that’s why global tracker funds require closer inspection.

This article is not personal advice. If you’re unsure of an investment for your circumstances, please seek advice. All investments fall as well as rise in value, so you could get back less than you invest.

Why the US dominates global trackers

In recent years the US has roared ahead of most other major stock markets. Combined with its already large size, this means the US now makes up more than half the global stock market. In fact, the ten largest companies on the global stock market are all American.

The performance of global trackers are therefore heavily reliant on the US stock market. The strength of the US over the past decade means that’s worked in investors’ favour, but there’s no guarantee it’ll always be that way, past performance is not a guide to the future. In the ten years after the turn of the millennium, for example, the US stock market lost money.

Too much tech?

There’s another part of global trackers we think investors should be aware of.

Just four US companies – Apple, Microsoft, Alphabet (Google’s parent company) and Amazon – make up more of the global stock market than any single country apart from the US.

The two biggest alone make up more than any country bar the US and Japan.

So with a global tracker you’re investing more in Microsoft and Apple than in China or Germany. These companies have performed well recently, so again investors have benefitted. But their future performance could be completely different.

Share of global stock market (%)

Source: ftserussell.com as at 31 January 2019

What’s the currency risk in global trackers?

For UK investors, global trackers also involve taking on a fair amount of currency risk.

Given the UK makes up a small proportion of the global stock market, and how much the US dominates, currency risk is something investors need to consider. If sterling strengthens against other currencies, particularly the US Dollar, that could hurt global tracker funds’ performance. Though of course the reverse is also true.

We don’t think investors should try to guess which way currencies will swing. But we think you should be comfortable with how much you’re exposed to currency effects and the potential risks.

Our view:

We think global tracker funds could be a great choice for a portfolio. But we think it’s sensible to add more diversification on top.

If you don’t want your portfolio to have a bias towards US companies, you could consider adding funds investing in other parts of the world like Europe or Asia. If you want to reduce your exposure to currency risk you could invest more in the UK. Some funds attempt to remove the impact of currency swings, although this usually increases costs.

Depending on your attitude to risk and investment goals you could also diversify into other asset classes such as bonds, or alternative investments such as real estate, infrastructure or precious metals.

Whatever choices you make, it’s important to understand where your money’s invested and the risks you’re taking. And remember, just because something’s done well in the past, doesn’t guarantee it will in the future.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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