Why you need international shares

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SMSF trustees need to tread a careful path between avoiding the trap of constantly switching shares to follow current fads and of remaining stuck in a portfolio, set perhaps years ago. This particularly is a problem when share valuations are at an extreme and when there might be some significant changes in the market.

Managing potential risks

We don’t know when the markets will change – though we can keep an eye out for warning signs – but investors can look at their portfolios’ upside and downsides on a “what if?” basis. Banks and institutions do this regularly; it’s called risk management.

While Switzer readers have varying share portfolios and allocations, the ATO’s figures tell us that, on average, SMSFs have below average or virtually no overseas shares compared with the large institutional funds. These patterns might be explained by risk aversion, following the GFC fright and the persistent high $A relative to the $US, which hobbles gains from US-denominated investments.

But the recent strong performance of the most likely share holdings – the banks, Telstra and BHP – in many portfolios is likely to have increased many share exposures. And, because these six stocks represent about 40% of the index, many funds could have a quite concentrated exposure to the share market. While such portfolios also have produced better returns than cash or short-term fixed investments, there is a greater risk of capital loss, if the share market gets the hiccups.

Realistically, there is a good chance that conditions will change sometime in 2014, when the US Federal Reserve is expected to ease its Quantitative Easing (QE) policy of injecting cash and holding interest rates low. In theory, markets should have built in some allowance for this, but whether markets are prepared or not, the US Fed’s action is likely to still affect interest rates, stock prices and the exchange rate.

In addition, the flush liquidity from QE has encouraged investors, with worrying signs emerging of over exuberance at the speculative end of the markets, as evidenced by the rush for Twitter shares. And it’s not just in the US; the India share market has been bubbling away and there has been a rush of hot new IPOs from China. All this suggests caution if the Wall Street stock market runs into major adjustments – whether from a rise in interest rates or just a change of investors’ mood.

Time for a change

Potentially, however, the biggest impact may come from the foreign exchange markets, if any Fed boost to bond yields lifts the $US in relation to the $A. This would improve local investors’ returns from holding US shares. While the gains would depend on the extent of the adjustment, it would reverse the recent pattern, where a stronger $A eroded gains from overseas shares. So the timing might be right for a tactical shift of some equity money from Australia to the US (or even Europe).

This might not entirely solve the problems of some over-priced shares (like local banks) but it would produce some geographical diversification into share portfolios and increase the quality of shares held.

Low-cost Exchange Traded Funds now enable a move into overseas markets via a listed index fund. ETFs are liquid, so investors can act quickly if conditions change. For those seeking exposure to top US stocks, iShares S&P 500 ETF (IVV) is one active fund. For a broader exposure, a SPDR fund based on the S&P world index, ex-Australia, (WXOZ) gives exposure to 25 overseas stock markets and I gave my broker an order last week to buy some WXOZ.

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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