Butterfly Effect in the Global Market Explained

The world has never been more interconnected than it is today. The theory of “the butterfly effect”, the idea that a relatively small event can reverberate across the world, has perhaps never been more valid given the speed at which ideas and news now flow across borders.

Events in far-flung corners of the globe can reverberate through financial markets. In today’s connected world, portfolios need to be constructed so they can respond quickly to changing conditions and market opportunities.

This was demonstrated more than a decade ago when increasing numbers of US homeowners began to default on their mortgages payments. Many of the mortgages had been bundled up and sold on to banks and investors around the world.

Consequently, the crisis spread rapidly with financial institutions unwilling to lend to each other and households cutting back on consumption. Falling demand prompted international trade and inward investment to slump, allowing the virus to quickly infect the entire global economy.

The global financial crisis is a particularly dramatic example of the butterfly effect but, in truth, we see examples of the interconnectedness of financial markets every day and everywhere.

Even if you focus your investments on the UK, you cannot be insulated from global events. 75% of FTSE 100 are overseas earners and nearly 25% are commodity companies. This means that events in far-flung corners of the world, such as North Korea, could impact UK shares via the dollar or commodity prices.

The value of an investment and any income from it can go down as well as up and can fluctuate in response to changes in currency and exchange rates. Investors may not get back the original amount invested.

The funds use derivatives, these can be complex and highly volatile. This means in unusual market conditions the funds may suffer significant losses.

The funds invest in emerging markets, these markets may be volatile and carry a higher risk than developed markets.

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