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The lure of offshore investing

Nicki Bourlioufas  |  16 Jan 2017Text size  Decrease  Increase  |  

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While there are undeniable benefits to international investing, it's important to consider how offshore investments fit with investors' goals, risk tolerance, timeframe, and portfolio.

 

It's now easier than ever for Australians to access international investments, and the official data shows we're sending investment money offshore as investors diversify their portfolios and take advantage of growth opportunities not available at home.

There are many ways you can gain exposure to overseas assets or markets, including through managed funds, exchange-traded funds, and even by investing in Australian companies with significant international operations.

Importantly, international investing lets you take advantage of growth in foreign developed and emerging countries that may be experiencing stronger growth than the Australian economy.

In addition, offshore investing allows you to gain exposure to sectors that are not well represented in Australia.

Jonathan Bayes, chief investment office with Prime Financial Group, says Australia's share market is limited in its diversity and is dominated by banks, miners, utilities and retailers--all "old-economy" sectors. This limits investment opportunities considerably.

"The big four banks alone comprise 25 per cent-plus of the ASX 300 Index and many portfolios would hold significantly more than this," says Bayes.

"When coupled with the large bank hybrid securities positions held by many investors, Australian investment portfolios have a particularly large exposure to the underlying health of Australian house prices, since banks, after all, make up the clear majority of their high-quality income from mortgage lending.

"In Australia, it seems, we are all tied to the one trade--housing."

As a result, Bayes say it's difficult for Australian investors to gain access in sufficient size and within appropriate levels of risk to the emergent economic and business themes of today such as the internet of things, social media platforms, new energy, e-gaming, and autonomous vehicles.

"Put simply, Australia's economy and share market offer scant prospects for exciting earnings growth in the coming two to three years at least," he says.

"Again, with such a concentrated share market, local investors are arguably locked into an inherently risky leverage to Australia's rampant housing market by virtue of the banks' substantial market weights and the related issuance by the banks of hybrid income securities."

There are some signs investors understand the need to diversify their portfolios. In terms of total managed funds assets in Australia, $474.2 billion was invested in offshore assets as at 30 September 2016, according to data from the Australian Bureau of Statistics, up 11 per cent from $425.5 billion a year earlier.

That accounts for 22 per cent of total managed fund assets, which totalled $2.18 trillion in the September quarter.

But not all investors are convinced. SMSFs, for example, collectively allocated less than 1 per cent of their assets to offshore equities during the September quarter of 2016, while almost one-third of their wealth was invested in Australian shares, according to recent data from the Australian Taxation Office (ATO).

So, there is ample room for SMSFs to grow international stock exposures.

But first, financial advisers say it's important for investors to consider how an offshore investment would fit with their investment goals, risk tolerance, investment timeframe, and portfolio.

Risks must also be considered. Investing internationally carries all the general risks of the underlying investments, but there are also other risks, including currency risk. Foreign investments are usually held in the local currency and asset values must be converted into Australian dollars to determine returns.

So, if the value of the Australian dollar rises against a currency, the value of investments held in that currency would fall. But the good news is that any drop in the Australian dollar magnifies gains when assets are converted into local dollars.

So, for example, if the Australian dollar fell by 10 per cent, the value of your offshore investments would rise by 10 per cent.

Given the Australian dollar has been dropping progressively through 2016 and it could fall further during 2017, should you be investing in hedged or unhedged international investments, or a bit of both?

This depends on factors such as your risk profile, how long you hold an investment, and your view on the currency.

If you decide to hedge, there is a cost to hedging and you can expect to add an additional fee of three to five basis points for an unhedged index fund and up to 10 basis points for an actively managed fund.

But like any insurance, that's a small cost compared to the returns you could be protecting if the Australian dollar appreciates. While the outlook is for short-term depreciation over time, according to economists, what goes down could eventually come up.

So, the question of hedging is best discussed with your financial adviser.

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Nicki Bourlioufas is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

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