How to add China to your SMSF

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For years, China has been the main driver of the Australian economy and stockmarket and yet retail investors still largely ignore most overseas stocks and cling to a strong “home bias” in their SMSF portfolios. Until now, it has worked; for over a decade or more, local shares have out-performed international stocks and anyone with BHP and Rio Tinto in their portfolio had the China play covered.

But is this stance still valid? A lot has changed and many of the old arguments against investing overseas or investing directly into China might need a fresh look. So the key questions are: should we buy overseas (and China) and, if so, how?

The argument for international

There have been plenty of reasons not to chase international stocks. The main one has been that out-performance by local companies enabled investors to ignore macro arguments. SMSF trustees can be conservative and risk averse: China’s economy is volatile and its stock market is challenging. International investing involves currency risk and doesn’t offer the attractions of those local franking credits. Buying Chinese shares direct isn’t really feasible and going through managed funds is expensive.

Still, the investment mood has turned back to favour shares and investors can now use a new tool – exchange traded funds – to invest internationally. Any change might still take time, but more investors now have a growing knowledge of overseas markets.

But the important analysis of an SMSF portfolio is not just the local versus overseas split; even with a local share portfolio weighted to the index, investors are likely to hold a sizeable weighting of China-led resource stocks such as BHP, Rio and Woodside, which can be volatile simply because of the cycles in resource prices.

Investors still need to have a long-term view on the sustainability of the China boom and believe that it will continue over the medium to long term – though not by double digit amounts. The message from BHP’s outgoing chief executive Marius Kloppers recently was encouraging and the board edged up its half-yearly dividend – something BHP doesn’t do unless it is confident dividends can be maintained.

SMSF investors still have to decide whether they should dip a toe in the international share pool to diversify their Australian share portfolios. While the home bias has worked a treat for local investors for a long time, if this reverses, investors might wish for some exposure to international stocks – especially if the Australian dollar were to ease further against the US dollar.

Better access

Finally, the opportunities to invest internationally have been transformed by those exchange traded funds (ETFs). These ASX-listed products offer a low-cost, liquid exposure which, for example, tracks indices like the FTSE China large cap or the MSCI Hong Kong. Both these ETFs have staged a recovery: the iShares FTSE China Large-Cap ETF (ASX Code IZZ) returned 15.5% in the latest year against 7.2% a year for the last eight years, while the iShares MSCI Hong Kong ETF (ASX Code IHK) did almost 26% in 2012 against 3.5% a year since 1996.

Perhaps, as the Gloom, Boom and Doom Report’s Marc Faber explained some years ago when the China boom began, rather than trying to make money by buying shares in Chinese companies making products for local consumers, you should buy shares in BHP and Rio Tinto to cash in on the huge demand for raw materials.

That’s still the default position for investors happy with a home country bias. It might be too early to be sure, but in the first few months of the market upsurge, China ETFs have at least matched Australian resource stocks. It’s a trend worth watching and buying to add a bit of something interesting around the edges of your portfolio.

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.

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