- When only three companies make 40% of an index that is no smart diversification whatever
- The fundamentals of the AEX show meagre future returns
- Finding the best stocks in the bunch is the only way for minimal risk and maximum returns
International diversification is a tricky subject as most investors are under the influence of the domestic bias (having a large part of your portfolio in the geographical area you are from). Such a bias exposes you to more risk as a single market is more volatile than a basket of markets. A good example of how a single market can be volatile is the AEX (Dutch stock index). It reached a peak of 689 points in August 2000, only to fall to 248 points in 2002, peak again in 2007 at 548 points, fall to 216 points in 2009 and slowly climb back to the current 453 points.
Figure 1 AEX since 1992
Such a volatile performance indicates that international diversification is essential in order to limit your downside. The downside can further be limited by analysing the indexes’ underlying valuations or the ones of the companies you are investing in.
Earnings are the best way to assess value as in the long term investment returns are perfectly correlated to earnings. The PE ratio of the AEX index is 35.74 while the dividend yield is 3.77% meaning that AEX companies are paying out more dividends than what they are earning which is not sustainable in the long term. Since inception (1983) the AEX has performed well with a yearly return of 7.21% but all of those positive returns had been made in the previous century.
Figure 2 AEX factsheet
On top of the terrible fundamental data the sector exposure of the AEX raises some red flags. Almost 30% of the index is in oil & gas (Shell) and personal & household goods (Unilever).
Figure 3 AEX’s sector exposure
So, if you think you are well diversified by holding an index like the AEX you are wrong because 30% of it is in two companies. If we add ING bank to the duo, we come to 40% of the total index which indicates the total futility of the AEX index.
What can be done?
What we will be doing here at European Stock Pics is offer you the opportunity to internationally diversify your portfolio by finding the best companies in specific European countries that will allow you to be well diversified but avoid the stupidity of holding an index where three companies make 40%.
If you are not into specific companies a good thing is to look at equally weighted indexes which give you proper diversification. The negative side is that they constantly trim your portfolio winners and add on the losers to keep the equal weight status.
Given the AEX’s volatility since the start of this century a better option is to look at all the companies in the AEX and find the best among them, do the same for each country in Europe and you are immediately well diversified by holding a portfolio of good companies. Continue reading European Stock pics as on top of weekly market insights like the above we are going to publish a monthly report on one European market, go through every stock and find the ones that provide the best potential returns for the minimal risk.
DISCLAIMER: This article was provided for informational purposes only. Nothing contained herein should be construed as an offer, solicitation, or recommendation to buy or sell any investment or security, or to provide you with an investment strategy. Nor is this intended to be relied upon as the basis for making any purchase, sale or investment decision regarding any security. Rather, this merely expresses my opinion, which is based on information obtained from sources believed to be accurate and reliable and has included references where practical and available. However, such information is presented “as is,” without warranty of any kind, whether express or implied. The author makes no representation as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use should anything be taken as a recommendation for any security, portfolio of securities, or an investment strategy that may be suitable for you.