Investing beyond borders
Regional indices can be better balanced and more diversified than almost any individual market
The choice between investing in single-country funds and regional funds is not simple. You can make a compelling argument that a portfolio of country funds has many advantages. Investing norms vary between countries for a variety of reasons, including legal and cultural differences. It’s arguably tricky for a manager to be on top of all of these nuances. There can be plenty of hurdles for individuals and small teams in making investment decisions across a region, including language barriers and other factors that make it harder to carry out research and due diligence.
Set against that, there’s one obvious limitation to many single-country funds. Is the market really deep enough for a manager to build a full portfolio of high-conviction investments? Or will they be adding some companies that perhaps aren’t as good to comply with their requirements to be diversified?
Not just an EM problem
It’s very clear when you look at some countries – particularly in emerging markets – that a single country fund can be extremely challenging: once you knock out stocks with poor liquidity or bad corporate governance, the choices often become very limited. You’d really struggle to assemble single-country funds in much of Southeast Asia or Latin America or Eastern Europe that come anywhere close to balancing diversification, liquidity and governance. In these areas, you usually want to go for regional funds.
Conversely, markets such as China and India are easily large enough for single-country funds, if you choose. But what of developed markets?
Some are so narrow that a single-country fund makes no sense: take Denmark, where Novo Nordisk is 55% of the index. You would never normally say this about the UK, France or Germany. Yet growing concerns about the shrinking UK market (see page 5) raise another interesting question. Would many investors be best served by a regional European fund, for example?
All the European markets arguably have some problems with balance or low exposure to certain sectors, but in aggregate the MSCI Europe index looks very well-balanced. Just in the top 10 you get food giant Nestlé, tech lynchpin ASML, luxury goods group LVMH, oil major Shell, bank HSBC and several pharma firms.
Europe has lagged US equities for more than a decade, but as a result the US is now 68% of the MSCI World index, which creates its own risks. Remember that Japan was once more than half the global market. Holding a large-cap Europe tracker fund alongside a US one is an obvious way to create a more balanced portfolio, while being much simpler than picking country funds.
“There’s one obvious limitation to many single-country funds”