If you have a wide portfolio of U.S. securities, containing everything from Johnson & Johnson to Ruby Tuesday, you would be forgiven for thinking that you were well-diversified.
But what if I were to tell you you're not actually diversified at all? In this two part series, I'm looking at two types of diversification that investors often forget about: international and internal diversification. This first installment highlights the importance of international diversification, while the second part deals with internal diversification.
You see, diversification is not just about companies in different sectors. It's about different countries, currencies, interest rates, and economies. In today's high-tech world, diversification is easier than it has ever been before. Investors are now able to trade on markets around the world in multiple currencies from the comfort of their living rooms. Indeed, I'm currently writing this in London, and by the time I've finished writing this sentence, I could have exchanged my pounds sterling to U.S. dollars and placed a trade on the NYSE.
For a perfect example of why you need to spread your investment wings outside of the United States, let's look at Japan back in the early 1980s. The Japanese economy had just finished nearly two decades of explosive economic growth, the stock market was hitting new highs, and it seemed mad to invest anywhere but Japan.
However, during the next two decades, the stock market more than halved and the economy stagnated, and interest rates have remained at zero for nearly a decade. Domestic investors who took bets on the U.S. economy during this period would have reaped impressive returns, while undiversified domestic investors suffered. If we can learn anything from Japan, it's that international diversification is key.
Red buses and the Queen of England
One of the best places investors can look for international diversification is London, as there are a huge number of international companies listed on the London Stock Exchange. One example is WPP (NASDAQ:WPPGY), one of London's -- and, indeed, the worlds -- leading advertising agencies.
Led by revolutionary CEO Sir Martin Sorrell, also nonexecutive director of Formula One and Alcoa, WPP has transformed itself during the past decade. Strategic bolt-on acquisitions and growth in mobile advertising have helped WPP become one of the most powerful forces in worldwide advertising and design. What's more, the global advertising market is worth around $500 billion annually, so WPP has plenty of room to expand.
Standing testament to WPP's profile is the company's performance over the past five years. For example, since the end of 2009, operating income has expanded 63%, and the company now churns out nearly 1 billion pounds in profit per year for a 15% return on shareholder equity -- the same as consumer giant Johnson & Johnson.
Center for finance
London is also considered by many to be one of the world's global financial centers and the gateway to Europe. This means that financial firms such as Prudential (NYSE:PUK) favor London as their destination for listing. Prudential has no relation to Prudential Financial, listed in the U.S. However, the company is of similar size.
While the U.S.' Prudential Financial focuses on domestic customers, London-based Prudential is reaping the benefits of growing wealth in Asia. Much like its U.S.-based peer, Prudential is focused on the business of life insurance. The company is benefiting from an aging population and a rising awareness of long-term savings needs within Europe, the U.K., and Asia.
So Prudential would fit the bill for a rapidly growing financial company based outside of the U.S. In fact, Prudential has more international exposure than many U.S.-based life insurance companies, so the company offers plenty of international diversification for your portfolio.
Closer to home
However, if you want to stay closer to home, you need look no further than the United States' northern neighbor, Canada.
Canadian oil sands are a highly lucrative investment. They can be costly to develop, but once production is underway, companies can easily achieve economies of scale that push the production cost down and profits up. Suncor Energy (NYSE:SU) is potentially one of the best oil sands investments. Indeed, the company has the backing of Warren Buffett through his Berkshire Hathaway entity. There is no hiding the fact that Suncor's performance is linked to that of the global economy, as the company requires a high oil price to make a profit. That said, as oil from oil sands is heavy oil, it is sold at the Brent benchmark, so the company is unlikely to be affected by the falling price of WTI.
What's more, Suncor's operations are not just confined to Canadian oil sands. Suncor produces oil around the globe, with operations in Norway, the U.K., and Libya. Suncor also has an additional level of security, as the company is vertically integrated. The company has its own refineries, mid-stream logistics, and tanker fleet, which ensures the company can set and achieve its own goals without having to rely upon other parties.
So all in all, international diversification is essential for the most diversified portfolio. Nowadays, it is easy to diversify internationally, and there are plenty of international companies listed in London that investors should take advantage of.
However, as well as international diversification, investors should also pay attention to internal diversification, which I cover in part two of this series.