Why UK investors should avoid turbulent overseas markets

As businesses become more global in their outlook so too do investors. Now more than ever we're seeing UK institutions and individuals looking aboard for their next big opportunity. There are a number of reasons for this, the first being income.

Many overseas companies pay higher dividends on shares than their UK peers, making them particularly attractive for investors looking for regular income. Some overseas investments also provide a healthy level of diversity in a portfolio - helping guard against regional or sector-specific fluctuations.

While the FTSE 100 is dominated by mining and manufacturing firms, one broker's list of the top 10 overseas stocks traded by UK investors includes seven companies in the technology space.

As these companies have enjoyed prolonged strong performance, there may be a level of crowd mentality at play here, with some investors jumping on the bandwagon in the hope of gaining exposure to a "hot" sector.

Careful consideration

Nevertheless, while these factors make investing overseas seem appealing, it demands careful consideration.

In late August emerging market stocks suffered their biggest drop in almost four years following China's shock devaluation of its currency. More than $5 trillion has since been wiped off the value of global stocks in the last two weeks alone.

With a considerable portion of the FTSE 100 market capitalisation being miners and reliant on China's demand to sustain prices, the impact on UK-listed equities has been significant. As we can see, the global economy remains fragile and there are still some further challenges ahead.

In the US for example, the pending interest rate rise is likely to cause economic jitters and have far-reaching consequences. While the move is a strong signal of American robustness, it could place businesses in developing countries, which have issued a large amount of US dollar-denominated debt, at risk of default.

The relative stability of the US has also made stocks look expensive, as judged by the cyclically adjusted price to earnings or "CAPE" ratio. Assessing prices on this basis, they are currently at levels similar to those seen in 2007.

While investors may be willing to pay these high prices for relative security, a large question mark hangs over whether such strong performance can be sustained - particularly in light of recent events in China. For these reasons, a number of investment funds are now turning their attention elsewhere - a move which others are likely to take note.

While Europe remains one of the cheapest markets in the world, those considering investing here should tread carefully. Deflation remains a major concern in the eurozone, as falling energy and commodity prices have helped quash the inflationary effects of the European Central Bank's quantitative easing programme.

Within this context, gross domestic product failed to reach growth expectations in the last quarter, standing at 0.3% against analysts' estimates of 0.4%.

Adding to Europe's woes - and to prospective investors' concerns - of sluggish growth and questionable profitability is Greece.

While a third bailout, worth approximately €85 billion (£62.17 billion) has now been agreed for the troubled country, the split of the ruling left-wing Syriza party and consequent snap election this month, again throws this - and the fragile sense of increasing stability it created - into jeopardy.

Against this backdrop, prospective investors could be forgiven for looking for a safe haven for their capital. Indeed, even in the UK we are troubled by the potential for interest rate rises, fluctuating unemployment and a severely overheated property market.

UK opportunities

Nevertheless, there are still investment opportunities within the UK that are less dependent on world markets and still present attractive short to mid-term returns.

UK medium-sized businesses account for only 2% of UK companies but produce 23% of the country's revenue. Looking at the success of the sector alone makes a compelling case for investment in it, but UK SMEs also have a number of other attractive characteristics.

Younger and less likely to be beholden to multiple stakeholders, they are often happy to work with investors to agree funding terms.

Debt finance in the form of bonds is particularly popular with business owners who do not wish to dilute their company, and can be attractive for investors, tired of pinning their hopes to market performance.

Should investors abandon overseas markets?

The answer of course is no. Rather, they should remember that diversity works both ways; that while overseas markets certainly present interesting opportunities, so too do the inventive, ambitious companies emerging from the UK.

Supporting them should not be considered an act of patriotism, rather one of good financial sense.

Chris Maule is CEO and co-founder of UK Bond Network.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.