How UK Investors can reduce risk and even the odds of success
Contributor: Graeme Evans | Interactive Investor
UK stocks have underperformed global peers in 2020, but investors can make sure they don’t lose out.
Spread risk and exposure - it's the golden rule of investing. And yet this rule is the one most likely to be broken by UK retail investors, who routinely favour home comforts.
To see why this can be a big problem, take a look at the MSCI All Country World Index. The benchmark tracks almost 3,000 of the world's biggest companies across 49 countries, with the weighting of UK stocks amounting to less than 4% at the end of June 2020.
Contrast this with the weighting for Wall Street stocks at 57.6%. Not only are domestic-focused investors limiting their portfolios to a very narrow list of UK companies, they are missing out on exposure to the world's biggest and often most exciting stocks.
They include the tech giants Apple and Microsoft, whose weightings have risen to above 3% in the All Country World Index. The other US-listed constituents in the top 10 are Amazon.com, Facebook, Google-owner Alphabet, healthcare company Johnson & Johnson and credit card giant Visa.
The US is home to far more quality and dynamic businesses than anywhere else in the world, which is why not being part of it can leave a large gap in an investor’s portfolio. This was demonstrated during the Covid-19 pandemic, when the tech-laden Nasdaq index managed to rise by 16% over the first six months of 2020, despite the devastating events taking place on Main Street.
The S&P 500 was down a modest 4%, compared with 18.2% for the FTSE 100 index as London's top-flight registered one of the worst performances of all the world’s major indices in the first half of 2020.
With mining, energy and financial stocks making up about 40% of the FTSE 100 index, the UK market was disproportionately affected by the fall in oil prices and rising bank bad debts.
International diversification can protect against this kind of underperformance, as well as deal with the perceived lack of technology and innovation in London's leading benchmark.
It's why increasing numbers of interactive investor clients have been looking Stateside. Our list of top 10 average holdings at the end of June shows millennial investors now have Apple and Amazon in their portfolios, alongside UK staples such as BP and Lloyds Banking Group.
As well as gaining a stake in the world's largest economy, this strategy provides exposure to factors not available to UK-only investors. US presidential elections are one example of potential market-moving events, while the policy decisions of the US Federal Reserve can often be at a different point of the interest rate cycle to that seen in Europe.
A weaker pound since the Brexit vote in 2016 has also made Wall Street a more attractive bet for UK investors, given that shares valued in other currencies become more valuable in sterling terms. Ongoing uncertainty about whether Downing Street can strike a trade deal with the European Union means investors may still need to offset the threat of UK volatility.
To do so, a US or global tracker fund might be an option for those not wanting to dip into individual stocks, or who may have become nervous about valuations in the tech sector.
Investing overseas for the first time doesn't have to be intimidating, with the processes no different to those involved in investing in UK shares. Technology has reduced dealing costs, made share prices more transparent, and speeded up the process of buying and selling.
And the best place for an overseas beginner is likely to be New York, where the two largest stock exchanges in the world are based and where there is no language barrier.
It is also worth remembering that the UK has double tax treaties with a large number of countries, but the onus is on the individual investor to reclaim that tax, most relevantly for dividend income. Any investor in US stocks should complete the W-8BEN form as that reduces US withholding tax from 30 to 15%.