Making money aside, diversification is the number-one priority for the majority of investors, as it ensures they are adequately protected from turbulence in a particular market or asset class at any given time.
Naturally, UK investors have traditionally been heavily overweight their domestic market, which has led to calls from numerous experts for them to move their cash further afield. Thus – the rise of the global fund.
However, FE Trustnet research suggests that investors looking for diversification away from the UK with these vehicles could end up disappointed, as there is a huge degree of correlation between the UK and Global growth funds.
A correlation of 1 means that two investments are perfectly positively correlated, while a correlation of -1 means they are perfectly negatively correlated. The score for the IMA UK All Companies and IMA Global sectors over a three-year period? 0.95.
One glance at the performance of the two sectors over the period and it is clear to see that there is a direct relationship between the sectors. You could even be forgiven for mistaking the IMA Global sector average for a poor UK All Companies tracker.
Performance of sectors over 3yrs
Source: FE Analytics
It is not only over a three-year period either: our data shows that the IMA Global and IMA UK All Companies sectors have a correlation of more than 0.94 per cent over five and 10 years as well.
The same is true when looking at the equity income markets – the correlation between the IMA Global Equity Income and IMA UK Equity Income sectors is 0.94 over three and five years.
Neil Shillito, director of SG Wealth Management, says that it is a problem that he has recently flagged up to his clients. "It’s an interesting question and one that I didn’t realise was such a problem until I met with some managers recently who voiced concerns over the matter," he said.
"They pointed to the fact that companies like GlaxoSmithKline make up a huge part of the global index these days. They may well be listed in the UK, but that doesn’t mean they’re UK based – they’re multi-national, global companies."
Rob Gleeson, head of research at FE, agrees. He also points to the fact that the sectors and even the individual companies that dominate the developed market indices are often the same, thus making them heavily correlated.
"The companies at the top of the various indices tend to be the same from country to country – although there are some exceptions, such as Apple in the US," he said.
"This means that there are little diversification benefits, particularly in such a globalised world economy where markets move increasingly in step."
"The main drivers for the indices are all the same, meaning that they can be expected to do well in the same circumstances, making a mockery of the notion of diversification, which is expressly intended to avoid this."
"Secondly, there is relatively little meaning to the place the market is listed any more. Companies listed on the London Stock Exchange are increasingly just multinationals which have found it convenient to be located here, and those in the US are those that have got a good deal to list there."
It is not only global and UK funds that are heavily correlated – the indices are too, though not to such an extent. The MSCI AC World and FTSE 100 have a correlation of 0.90 over a three-year period.
Shillito thinks it is becoming difficult for managers to diversify, but says that UK managers remain biased towards the UK, which does not help matters.
"I’m surprised by the lack of weighting to the US in a number of the funds," he added.
He is currently backing FE Alpha Manager James Thomson’s Rathbone Global Opportunities fund, which has four FE Crowns.
The fund has a large exposure to the US, with a 50 per cent weighting in the portfolio. It has a correlation of 0.86 to the UK All Companies sector over three years and is a top-quartile performer in its own sector over three- and 10-year periods.
Performance of fund vs sector over 10yrs
Source: FE Analytics
Brian Dennehy (pictured), managing director of Dennehy Weller & Co, says the high level of correlation across the markets presents a problem for investors, but he still says there are merits of investing internationally.
"We live in a global economy," he said. "Pretty much every market you look at is highly correlated to the other." "That said, there is still a benefit of diversifying, in that some markets will give you better performance at different times, even though they go up and down together. In this way, the main benefit is really on the upside, rather than on the downside."
"There are some exceptions to the rule though. Japan and the US aren’t directly correlated – for example, in the 1980s Japan did brilliantly and the US was the dog, and then in the 1990s the opposite was true."
According to FE data, the S&P 500 and the Nikkei 225 have a correlation of just 0.49 over the past three years. He also points to China as a market that has historically been uncorrelated with other global indices.
Dennehy says he has little exposure to global funds because he likes to do his own asset allocation. He is currently bearish on the US, but sees good long-term potential in China.
He says it is disappointing that more global managers don’t look to deviate away from developed markets like the UK, the US and Europe, so as to make themselves more distinguished from the UK market.
Later on today, FE Trustnet will look at some IMA Global funds that have little correlation to the wider UK market.