Careful investors like a nice spread to enjoy the feast

Investors in the Gulf are known to favour certain asset classes. Property and local equities have certainly been the core of many locally held investment portfolios. However, if there is one lesson that we can all learn from the region's major institutional investors, it is the importance of investing in a more diversified way.

In the second article of our investment fundamentals series, we look at the importance of spreading your money across a range of funds that invest in markets around the world. Your home market can be a great place to start investing, but because different stock markets tend to perform well at different times, it is a good idea to look further afield as your portfolio grows. This is one of the most effective ways to achieve consistent long-term investment returns with an acceptable level of risk.

Geographical diversity

This strategy is known as diversification, and can increase the potential of benefiting from growth in a market that is currently doing well, while also reducing the effect that any falling market may have on the value of your investments.

Picking a winner is difficult. The world's major markets are all very different. They may be affected by the same issues, but they won't necessarily react in the same way. In addition, they are influenced by their own business cycles, economic trends and political, social and cultural factors.

A portfolio that focuses on an investor's home market may produce the returns hoped for from time to time, but 'putting all your eggs in one basket' can be detrimental. A single market or single country portfolio is restricted in its ability to capitalise on the enormous investment potential available around the world, it can lack diversification and as a result volatility and risk can go up.

Consider the table which shows the performance of five geographical regions, and the world, since 1996. As you can see, all five regions have been the worst performing for at least one calendar year, whereas diversifying globally will avoid the risk of potentially selecting the worst performing area.

Sectoral exposure

Having a portfolio that invests entirely in your home market may also mean you miss out on investment opportunities in some of the world's most important industries, also known as sectors, such as banking, pharmaceuticals and retail. A breakdown of the world's 10 biggest markets demonstrates that different countries tend to favour certain sectors and have less exposure to others. Few countries offer effective diversification across the entire range of sectors, so if you limit yourself to one country, you may miss the opportunities offered by industries under-represented in that market.

For instance, as of March 31, MCIS Indices, whereas financials tend to take the leading share in almost all the top 10 markets (with 21.7 per cent in the US, 27.1 per cent in the UK, 20.6 per cent in Japan), there is considerable diversity.

In the US, the next sector is information technology (15.4 per cent), then healthcare (11.7 per cent), whereas in the UK the second sector is energy (15.4 per cent) and the third is consumer staples (12.4 per cent). In Japan, the counterpart sectors are consumer discretionary (20.1 per cent) in second place followed by industrials (17.7 per cent) in third. In Switzerland, the seventh-biggest market, are healthcare (30.9 per cent), financials (30.8 per cent) and consumer staples (17.4 per cent). Australia, the eighth market in terms of size, is skewed towards financials (47.2 per cent) with materaisl next (21.1 per cent), and Italy (the tenth biggest) even more so (50.1 per cent in financials) with energy second (16.9 per cent).

The exposure to different sectors is important for the region's investors, as most Middle Eastern and African markets are still developing and focus on limited sectors compared to many world markets.

The writer is Director, Sales, Fidelity International Dubai.