Key points

• Strong reasons to invest offshore include the size of our market– less than 2% of global stock markets by capitalisation – and its overexposure to financials.
• With a stronger US dollar, emerging markets just won’t attract investor flows. So a position in both Europe and the USA is probably the call.
• Deciding whether it’s too late or not will depend on existing exposure. If you don’t have any international it’s definitely not too late.

If I had to nominate the number one question from investors at the moment – “is it too late to invest offshore?” must be right up there. The hard data from the ATO says that SMSFs are way underweight exposure to offshore investments compared to their institutional counterparts, or the exposures recommended through traditional asset allocation models.

With the Australian dollar having fallen by more than 30% from over 1.10 US dollars to 0.76 US dollars, and US and European markets trading near record levels, it is not surprising that some SMSF trustees fear that the boat may already have sailed.

My answer to this question depends a little on your exposure and objectives. If you are a long-term investor and have no or limited exposure, then “no”. If you are positioned close to your recommended weight, or want to play it more from a trading perspective, I think you can afford to be patient and wait for better opportunities.

More on this later. First, let’s do a quick re-cap on the “why”, “where” and “how”.

Why invest offshore

There are three very strong reasons to invest offshore. Firstly, the Australian market is so small – less than 2% of global stock markets by capitalisation. This means that 98% of opportunities are outside Australia.

Secondly, our market is dominated by financial and resources stocks. The financials sector makes up 40.9% of the Australian market, compared to 16.0% in the USA. For materials, it is 15.4% compared to 3.3%. Conversely, information technology stocks make up 19.9% of the US market compared to a trifling 0.8% in Australia. Our market simply doesn’t have the Apples, Googles, Microsoft or Facebooks, or in the healthcare sector, pharmaceutical giants like Pfizer.

Thirdly, international share markets will often outperform the Australian market. While this can be true over any short-term period, it is also true over a longer period. The following graph from the RBA shows the Australian (black), US (red) and World (developed markets, blue) over a 20-year period, using a common base and logarithmic scale. Over this longer period, the US market has outperformed the Australian market.

Where to invest?

The MSCI World Index, which is a leading global share index, captures almost 1,700 large and mid-cap stocks from 23 developed markets. In this index, stocks from the USA account for 58% by market weight, with Japan and the UK stocks coming in second and third respectively at around 8% each. France is fourth with a share of 3.8%.

In a relative sense, emerging markets such as India, Brazil or Thailand are very small.

Further, the US market is the lead market for most others. If the US market catches a cold, it is very hard for other markets to sustainably move in the other direction.

So, investing offshore for many investors is firstly about whether to invest in the USA or not. While you can just invest in emerging markets or Europe, it is higher risk not to have some exposure to the USA. Over the last 20 years, the US market has outperformed the other major markets, as the following graph from the RBA chart shows (US in red, Euro area light blue, UK purple and Japan brown).

More recently, the European markets have started to narrow the gap, as “quantitative easing European style” starts to take effect.Source Bloomberg, to COB 13 March 15

Going forward, if you followed what happened in the USA, an overweight position in Europe is probably still the way to go. The impact of QE is likely to be bigger (on the stock markets) than anticipated. However, you simply can’t ignore the USA.

With a stronger US dollar, emerging markets just won’t attract investor flows. So a position in both Europe and the USA is probably the call.

How to do it

Many of the major brokers (CommSec, E*Ttrade and nabtrade) provide facilities to invest directly in individual shares or other securities that trade on the major exchanges.

However, most investors will probably prefer exposure through a broader based, managed investment. The question then becomes whether to have that managed passively or actively.

Exchange traded funds are passively managed investments that are designed to track a major index such as the S&P 500. Traded on the ASX, ETFs generally have very low management fees because they are effectively on “auto-pilot”. Your return will be the same as how the index performs less the management fee – nothing more, nothing less.

These are the ETFs to use:

For an active manager, you may wish to consider some of the listed investment companies. Investment styles and areas of interest vary. These are the major LICs to consider.

Is it too late?

One of the major considerations about investing offshore is the direction of the currency. While you can find hedged investments (funds or ETFs that hedge their currency exposure, such as WXHG from SPDR that invests in the World ex Australia with currency exposures hedged), many investors will typically try to align the timing of their offshore investments to an expected weakening in the Aussie dollar.

Where is the Aussie dollar heading? Most commentators expect further short to medium term weakness. This includes the RBA, who have not hidden their view that the local currency is overvalued.

On a longer term basis, the Australian dollar looks to be approaching what many would consider to be fair value (around 0.75), but overvalued compared to the YEN and EURO. An overshoot (that typically tends to happen) may see the Aussie trade starting with a big figure ‘6’. The following chart from the RBA provides a 30-year perspective (USD red, YEN brown, EURO blue).

And offshore markets? As Peter has discussed, we don’t see any immediate threat to the bull market continuing in 2015 and 2016. That doesn’t mean that there won’t be a pullback, however there is no reason yet to suggest that the trend has changed. Although the European markets have run hard over the last couple of months, the US bull market looks more mature and interest rates will go up there first. There is probably still some value in Europe.

Bottom line – for a long-term investor with limited or no exposure to offshore markets, I don’t think it is too late. If you are already invested or want to trade your position, perhaps wait for a bit of a pullback in both the equity and currency markets.

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.