As anyone investing online into an ISA or SIPP should know, over the long haul a good level of diversity within an investment portfolio has been demonstrated by numerous studies as resulting in the best long term returns.
Diversity reduces exposure to any particular investment or group of investments taking a major hit. Statistically, this is more important to consistent long term returns than banking on a section of investments realising especially high returns. Diversity in an investment portfolio with an online stock broker is achieved by allocations to different asset classes such as equities, bonds, commodities and cash.
Diversification is also necessary within asset classes and one good way to diversify an equities holding, as well as by sectors and company size or growth rate is by investing in different geographies. With that in mind, a recent study by online stock broker Hargreaves Lansdowne looks at the international equities markets that currently offer the best, and worst, value.
Assessing if a country’s equities are expensive or cheap can be done in a number of ways. The first of these is the price to earnings ratio (p/e) which is calculated by dividing a company’s share price by its earnings. This can be done for all of the listed companies on a particular stock exchange together to find a combined country or exchange p/e ratio.
Another way to do this, considered more reliable, is the cyclically adjusted p/e or Cape ratio. This takes the current market capitalisation of a company or stock market and divides it by the average earnings over the past 10 years. This lessens the chance of judging value on the basis of earnings that might be experience a short term and unsustainable peak.
The final popular value metric used by analysts is the dividend yield of a company or market. This divides market cap by dividend yield and can be compared to the same market’s long term average to assess current value for money.
The conclusion of the study is that based on a combination of the three metrics, Japan, China and Emerging Europe (mainly Eastern Europe and Russia) are markets that can currently be considered ‘cheap’. On all three metrics they are currently valued below historical averages. Most other international markets are close to historical averages or show divergent readings across the different metrics.
The USA, however, was the only market to currently be ‘expensive’ across all three metrics. The current p/e ratio in the USA is around the same as it was last year but on Cape it the market is now more expensive. Most emerging markets look cheap, particularly Russia, though this is clearly due to geo-political risk being priced in by international investors. Having shown some of the best international returns in the world over the past few months, Brazil’s equities now look the priciest of developing markets.
The UK is hard one to call. Against historical averages it still looks pricey on p/e and dividend yield but p/e is much lower than it was a year ago following the dip over the last few months. Many investors consider UK equities a good contrarian bet as despite Brexit uncertainty there are many world class companies on the London Stock Exchange whose revenues are not highly exposed to the domestic market.