There is no doubt Australians are intrepid travellers. Last financial year some 9.1 million Australians headed overseas. But when it comes to investing, Australians, particularly SMSF investors, are slightly less adventurous than they probably could be.
SMSF investors held just 0.65 per cent of their portfolios in international shares at September 2017, according to the ATO. But they had a huge 29.5 per cent allocated to domestic shares, despite the Australian market representing just 2 per cent of the global market.
Australians have a definite home-bias which has created highly concentrated portfolios.
But if Australian investors take the same attitude to investing as they do to travel, and begin exploring international shares, they will not only find amazing investment opportunities around the world, but also significantly enhance portfolio performance.
An understandable bias?
Some may argue that Australia’s investing home-bias is justifiable.
Of course, people want to invest in what they know. The Australian market doesn’t have the complication of currency volatility. Investors also receive tax benefits, particularly franking credits on dividends.
And Australians shares tend to generate high dividend yields relative to global shares, which makes them a good source of income.Below is an average SMSF portfolio in comparison to Australia's sovereign wealth fund, the Future Fund, which has significantly higher exposure to international shares.
However, an over-exposure to the Australian market can create several risks.
Investors are overexposed to the Australian economy and the $A, both of which are vulnerable to cyclical changes in commodity prices.
A small number of sectors
Investors are also overexposed to a small number of sectors. The Australian stock market is dominated by a handful of banks and miners, with a few retailers and a telco (Telstra).
But perhaps the biggest problem with our home-bias is missed opportunity.
By investing locally only, Australians are missing out on opportunities in big global companies such as technology giants Google, Apple and Facebook.
Our poorly diversified portfolios have hurt us in recent times
The Australian market has significant underperformed in the past year, with the ASX200 returning just 2.54 per cent, against 13.93 per cent for the MSCI World Index (excluding Australia).
As you can see in the chart above, if an investor had put $100,000 into the ASX200 five years ago, they would have $149,929 now. But if they had split their holdings 50/50 between local and international shares they would have $188,354 -- $38,425 more.
The solution, of course, is to increase our allocation to international shares.
Diversification doesn’t always generate higher returns. But it improves risk-adjusted returns: investors get more return for the risk they take. If the Australian market hits a bad patch, other markets will be outperforming. Overall that produces a smoother ride for investors.
Big, sophisticated investors in Australia know the power of a diversified portfolio and have much higher allocations to international shares than SMSFs.
A greater percentage of international shares
At June 30, 2017, large Australian Prudential Regulation Authority (APRA) super funds had 23 per cent of assets in Australian shares and 23 per cent in international shares.
Even the Future Fund, Australia’s sovereign wealth fund, which you might think would have an Australian bias, has significantly more exposure to international shares than SMSFs.
The Future Fund held 6.4 per cent of its portfolio in Australian equities, but a substantial 26.3 per cent in global equities according to its latest Portfolio Update released on December 31, 2017.
How do Australian investors gain exposure to overseas markets?
There are many ways to gain international exposure, including buying specific stocks such as Google or Toyota.
Investors can also invest in geographic areas or countries, such as China or the US. But international shares are also divided into three categories based on economic development.
1. Developed markets
Developed market economies are more mature and have lower growth outlooks but offer relative portfolio stability. They are the wealthy economies like North America (the US and Canada), Europe (UK, France) and Japan. But they also include some more mature Asian countries, such as Singapore and Hong Kong. Australia is a developed market.
2. Emerging markets
Emerging market economies have greater growth potential, and can spice up portfolio returns, but also come with greater risk and volatility, which typically leads to smaller allocations than developed markets. (The Future Fund’s international equites allocation included 18.6 per cent in developed markets and 7.7 per cent in emerging markets.)
Emerging markets include 23 countries spread across the Americas, Europe, Middle East and Africa. It also incorporates the significant BRIC countries (Brazil, Russia, India and China) and several smaller nations such as Poland, Peru and Taiwan.
3. Frontier markets
There is an even higher risk group of markets, known as Frontier markets, which includes the likes of Kenya, Lebanon, Vietnam and Argentina. They are too small to be considered emerging.
Frontier markets are typically risky, with political instability, market volatility and poor liquidity and therefore warrant a small allocation.
There is another way to gain international exposure: thematic investing. Thematic investing allows investors to profit from big, sustained trends.
Most megatrends, such as ageing, the rise of the Asian middle class and disruptive technology, are global in nature. That means it is difficult to invest in them if you are only in Australian companies.
If we look at water scarcity, for example, Australia suffers from that problem. But there are few opportunities to invest in that thematic on the ASX. The best opportunities are not necessarily in Australia.
Most investments in Macrovue’s Water Liquid Gold portfolio are listed in Europe and the US. That includes Spanish conglomerate Acciona, which has a significant proportion of its operations in developing water-efficient energy.
The Australian stock market delivers investors many tax and income benefits, but like never travelling overseas, only investing in the Australian market can limit our horizons.
By pushing offshore, Australian investors can gain exposure to some of the most exciting companies and countries on earth. And, perhaps most importantly, profit from some of the biggest global trends in the history of mankind.
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Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.