- Developed world markets, let by the US, are likely to take centre stage next year.
- Investments made now, will – if they make a capital gain – increase further in value in Australian dollar terms if the Aussie moves lower.
- The intention to invest in international shares by SMSFs almost doubled from the 2013 to 2014, from 12% to 22%.
Looking at the headlines, it is easy for Australian investors to get worried about 2015, as falling commodity prices on the back of the China slowdown, hammer sentiment on the local market, and on the global front, concerns mount over the European and Japanese economies.
Rosy outlook
But global shares actually look to have good prospects in 2015 – even in some of the economies that are struggling – and self-managed super fund (SMSF) portfolios should be looking to pick up on this theme.
As Credit Suisse puts it, developed-world stocks are likely to “take centre stage” in 2015, led by the United States, which the investment bank says has entered a “self-sustaining recovery.” Many of the big US-listed tech stocks and financial stocks are very well-priced, particularly some of the beaten-down banks. US large-cap stocks are also likely to be stable in times of volatility. In fact, many of the top US stocks are effectively “global mega-cap” stocks, because they generating revenue all over the world. The big global technology stocks are expected to continue to do well in 2015.
Because economies and sharemarkets do not always move together, even though Japan and some of the Eurozone economies, including France and Italy, are effectively in recession, share valuations are favourable given the prospects for company profits. Both economies are receiving heavy stimulus, and currency weakness boosts their big exporters.
The US economy should provide the driving force for the global economy in 2015. Given the likely continued downturn in Chinese growth data expected next year, and the Australian economy’s struggle to make the transition from being driven by the mining sector to the non-mining sector, SMSFs need greater offshore diversification, not only to protect their portfolios but to tap into those areas where there is greater potential for growth.
It’s also likely that investments made now, for example US stocks at exchange rate levels around 82.5 US cents, will – if they make a capital gain – increase further in value in Australian dollar terms as the Aussie moves lower over the course of the year, as is widely expected.
Good diversification
But aside from all these considerations about market moves in 2015, a SMSF that does not have global shareholdings is not investing sensibly.
Australia is a small market in the global capital pool – about 2% of the capitalisation of world stockmarkets – and it is also a very concentrated market, which works against diversified investment. The financial sector represents about 40% of the S&P/ASX 200 Index: BHP represents about 10%. The big super funds know that this brings high levels of concentration risk: they know that having a diversified portfolio means investing overseas.
Moreover, the Australian market does not provide access to high-quality, profitable exposures to industries such as technology, telecommunications equipment, aerospace, pharmaceuticals and the big consumer-goods companies. Very often, these are outstanding stocks when it comes to earnings growth, return on equity and distributing money back to shareholders. For these exposures investors really have to look offshore.
Increasingly, the big super funds want to play in this pool of the top global stocks. According to investment consultants Towers Watson, within ten years Australian super funds are likely to allocate 60% of their equity investments to foreign markets. At the moment this allocation is around 25%. The big super funds know that this change is coming, as the massive superannuation pool outgrows the Australian stock market’s capacity to absorb it.
In contrast, self-managed super funds (SMSFs) are not big offshore investors. According to the Australian Taxation Office (ATO), at June 2014 SMSFs held just 0.4% of their assets – $2.2 billion – in overseas shares, compared to 32.1%, or $179.4 billion, in domestic shares.
In large part this discrepancy is explained by the huge demand from SMSFs for franked dividend income. But even with the strong home bias on the back of the dividend franking system, the argument for international diversification – and the need to tap into the big globally-oriented stocks – does not go away.
Good intentions
Despite the low base, it seems that Australian SMSFs are getting the message. Earlier this year, Vanguard and Investment Trends released the annual results of the 2014 Self-Managed Super Fund Report, taking a detailed look at the challenges for Australian SMSF investors, and their likely responses. Despite the reasons SMSFs gave for not investing overseas – insufficient knowledge of overseas markets (40%), currency risk (34%) and the lack of franking credits (33%) – the intention to invest in international shares by SMSFs almost doubled from the 2013 survey, from 12% to 22%.
While there is always currency risk in investing in another currency, many of the big super funds see foreign currency exposure as effectively another level of diversification, away from their Australian dollar base. Investors can choose to ‘hedge’ an overseas investment – that is, run it in the foreign currency, so that currency fluctuations do not affect the returns – or leave it unhedged (that is, in Australian dollars). Hedging will help you if the Australian dollar rises, but it’s better to be unhedged if the Aussie is falling like it is now.
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.
