Factors To Consider When Going Global With Your Asset Allocation

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Please note: This is a guest post from a financial analyst who works closely with global asset allocation and listed investment companies (LICs). Steve enjoys investing LICs and focuses on event-driven and activist investing. He has over 20 years’ experience working in the investment management industry and is now primarily focused on managing his own investments. You can follow some of his ideas at his investment blog at https://valueinvestingforaliving.com/. The following article is the opinion of the author and not Financial Framework. The following article should not be considered financial advice and is only general in nature.

The most common reason I hear for Australian investors to get exposure to overseas markets is that the Australian share market represents less than 2% of the world’s opportunities. This is a valid reason but there are plenty of other factors to consider that are given less attention from the financial media.

Considering overseas investments to minimise downside risks can also be worthwhile.

With the benefit of hindsight, the financial media likes to highlight returns from the Australian & U.S. equity markets over the last century. We are now aware that these happen to be two of the best markets you could choose. The question being posed though is whether we should be cherry picking these markets and their historical returns for future planning?

Would we have chosen them over 100 years ago? And why should we consider them today?

Refer to the below pie charts.

Global Share Market Pie Graphs

In the past, the U.K. was the largest so perhaps they were the obvious choice? Well unfortunately that would have resulted in about 1 or 2% less real returns than in Australia or the U.S.

Don’t forget the Germans, they were the 3rd largest back then and may have been a likely choice as well. However investing in Germany may have meant you would be lucky to have earnt half the real returns achieved by Australia or the U.S. over the long haul.

How about fancying Russia in 1899, they were 5th largest. Well, their stock market closed in 1917 and you would have lost everything…

Real returns on equities

Admittedly I am cherry picking examples that seem so long ago and far-fetched in terms of today’s world. Yet just prior to 1990 Japan’s share market was easily the largest in the world. Their index is still more than 40% lower, almost 30 years later! Investors may reasonably point out now though that bubble like conditions there were obvious at the time.

If the Australian share market performed poorly in the future though led by our banks, I can envisage what some would later write. I am sure with hindsight many would later claim that a property bubble was obvious at the time. This intern meant it was clear to underweight Australia’s bank heavy share market.

I want to make it very clear though by no means am I predicting poor returns for Australian shares.

The underperformance in recent years might even make them attractive. Perhaps future population growth may still act as a handy tailwind for many of our larger companies. I am merely questioning the need to bet entirely on one country’s stock market.

These days we have an extensive choice of investment products delivering offshore exposure. For the most part, these investment products are coming at much cheaper costs compared to many years ago.

When investing in a single country’s stock market you are running a risk. if you happen to pick the wrong one it could be a case of sacrificing a few per cent in real terms each year or even worse.

An argument some use for investing solely in the U.S. is the fact that many companies have significant offshore earnings anyway. A problem with that line of thinking though is if the U.S. market gets hit by a poor local economy then it can affect the sentiment of all listed companies. Even valuations of global firms may stay depressed.

Some multinational companies listed in Japan have experienced this negative sentiment despite their international performance.

I can understand the temptation to largely stay invested in Australia. Our dividend imputation system can be very attractive to many. It is also comforting at times to know your returns don’t deviate from fluctuations in world exchange rates.

Regarding taxes it is certainly prudent to be fully aware of potential tax breaks. However, is it worth placing huge bets that current tax advantages will be there long term? By all means include your fair share of fully franked dividend paying companies in a portfolio, I know I do. But be careful of basing your whole strategy dependant on our politicians.

Exchange rate volatility is often cited as a reason to avoid overseas investments. I can’t guarantee how our currency will perform in the future, but I think it is worthwhile noting some history of the last decade.

During the GFC the Australian dollar declined sharply. That meant that overseas investments where the currency was unhedged performed much better all other factors being equal.

A falling Australian dollar could mean your unhedged overseas investments that are outperforming may protect you from other consequences.

Is our exchange rate suffering due to the employment sitatuion worsening? If your employment was with one of our major banks and your job became vulnerable from deteriorating prospects, probably better to have not bet the house on 100% in bank shares! A falling local currency is also often associated with higher inflation rates that negatively impact your cost of living.

Personal issues such as your job prospects and where you plan on living can make the international asset allocation decision very much an individual choice. There are also risks in going too far and not holding enough Australian assets. Perhaps an individual accepts an overseas role that turns out to be a lengthy one.

Living as an expat, it can be easy to get caught up in your new home base. In recent history if you had embraced overseas investments too much it could have proven costly.

What if you went away on a working assignment to a new country and held no Australian investments for a decade? If your expectation was that you could return home to Sydney or Melbourne a decade later and pick up a cheap home again then you would be sorely disappointed.

Conversely maybe your long term retirement plan is to spend a lot or nearly all of your time in an overseas destination. In that case some exposure to foreign investments may make more sense compared with others. These are all reasons to avoid placing too much emphasis on reading about any financial guru and what their international asset allocations may be at any given time. They will likely have completely different goals.

The jurisdiction you hold the assets in can also be very important to consider. Expats or future retirees might find the idea of buying homes overseas a charming thought but should tread carefully. Emerging market destinations can be risky from a legal & political sense and subject to changes in foreign exchange control rules at times. Even if you plan on buying in a more developed country with a stable legal & political system, there are many factors to consider.

Just from the perspective of being clear whether you are classified as an Australian tax resident is crucial. An understanding of all of the implications is critical and advice is often worth paying for if heading down this track.

Even holding some direct shares in U.S. companies could end up being more complicated than you think. You should first understand all of the taxation implications. Withholding taxes and estate taxes can surprise investors when they learn about them further down the track.

The above article was not meant to be pro overseas shares v Australian shares or vice versa. The article simply points out some factors that an investor may forget about when they are trying to decide how much exposure to have in domestic versus offshore assets. These are often the forgotten factors considered when going global with your asset allocation.

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