Whenever there is a major market movement, reviewing your allocation to the various asset classes and individual investments is good practice. The Coronavirus, and the ensuing global shutdown of many businesses, is clearly one of these times.
One of the questions that many are asking is “should I continue to invest offshore, and if so, is now the right time to increase exposure?”.
My answer to the first question is that I can’t see any reason why you wouldn’t continue to invest offshore. You might want to consider where you are investing (for example, it looks like parts of Europe and some of the emerging economies could be slower to recover), and in terms of allocation, this will largely depend on how much you have already invested offshore. With the Aussie dollar near 60 cents, there is arguably less of case to go offshore than there has been, at least not on an un-hedged basis.
More on this later. First, a quick re-cap on the “why”, “where” and “how” of investing offshore.
Why invest offshore?
There are 3 main reasons to invest offshore.
Firstly, the Australian market is 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 resource stocks. The financial sector makes up 28.0% of the Australian market compared to 10.9% in the USA. For materials, it is 18.3% compared to 2.4%. Conversely, information technology stocks make up 25.5% of the US market compared to a trifling 2.5% in Australia. Our market simply does not have the Apples, Alphabets, Amazons, Microsofts or Facebooks, or in the healthcare sector, pharmaceutical giants like Pfizer, or consumer giant Johnson & Johnson.
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 performance of Australian (black), US (red) and World (developed markets, blue) over a 25 year period, using a common base and logarithmic scale. Over this longer period, the US market has outperformed the Australian market.
Even over the more recent period, the US market has outperformed. In the March quarter, the Aussie market lost 23.1% (including dividends) whereas the US lost 19.6% . In the month of April (to Friday), the US market is up 9.9% while our gain is a more measured 3.3%.
Where to invest?
The MSCI ACWI Index, which is a leading global share index, captures 3,047 large and mid-cap stocks from 23 developed markets and 26 emerging markets. In this index, stocks from the USA account for 56.6% by market weight, with Japan coming in second at 7.5%, China third at 4.8% and the UK fourth at 4.3%.
In a relative sense, emerging markets such as China (excluding Hong Kong, which is classified as a developed market), South Korea, Taiwan, India or Brazil are small. In aggregate, less than 15%.
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 25 years, the US market has outperformed the other major markets, as the following graph from the RBA shows (US in red, Euro area light blue, UK dark blue and Japan orange).
Since the GFC, the USA and most developed markets have outperformed emerging markets. The following graph shows the Developed World (in black), Emerging Europe (green), Latin America (purple), China (pink) and Emerging Asia (orange).
A key issue for emerging markets is the strength and direction of the US dollar. In theory, a weakening US dollar is a positive for emerging markets, while the opposite of a strengthening dollar (which is the more recent trend) is a negative.
How to do it
Many of the major brokers (CommSec, nabtrade etc.) provide facilities to invest directly in individual shares or other securities that trade on the major exchanges. You might, for example, be interested in the FAANG stocks (Facebook, Apple, Amazon, Netflix and Alphabet [Google’s parent]) or their Asian equivalents, stocks like Baidu, Alibaba or Tencent.
For the occasional offshore investor, nabtrade offers an excellent service. $19.95 brokerage on a trade between $5,000 and $20,000, with no custody fee provided you do at least 1 trade annually. There is, however, a spread on the currency conversion which applies to both buys and sells.
Many investors will probably prefer exposure through a broader based, managed investment. The question then becomes whether to have that managed passively or actively, or a combination of both.
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 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 and ASX quoted managed funds. Investment styles and areas of focus vary. These are some of the major funds to consider.
Magellan and WCM (the manager of WQG and quoted fund WCMQ) boast remarkable performance records and have demonstrated that their investments tend to be less impacted in poor markets. But as “bottom up, conviction style” managers, “manager risk” is a consideration for investors, who may care to diversify by spreading their investment across different managers.
It is important to disclose that I am a Non- Executive Director of WQG and could be considered to have a conflict of interest when it comes to discussing WCM and WQG.
Hedged or unhedged?
One of the considerations about investing offshore is the direction of the Australian dollar. Active managers will often prefer to manage the currency risk dynamically, hedging when they believe it is appropriate. Some active managers will hedge all exposures, while others will run an unhedged exposure.
Many exchange traded funds now give investors the option of taking a hedged or unhedged currency exposure. For example, iShares IVV tracks the US S&P500 index and exposures are unhedged, while IHVV tracks the same index but exposures are hedged back into Australian dollars. The hedged version is typically a little more expensive.
Where is the AUD heading? It has been in a downward trend for some time, with the most recent weakening coming as the Covid-19 crisis took hold and put downward pressure on non-agricultural commodity prices. At 70c, most in the market felt that the direction was south, whereas at 60c, the market seems somewhat more relaxed.
On a longer term basis, the AUD looks to be below what many consider to be fair value (around US 70 to 75 cents). The following charts from the RBA provides a 36 year perspective. The first chart shows the nominal exchange rates (USD vs the A$ in red, Yen in brown and Euro in light blue), while the second chart shows the trade weighted index.
Although not normally a fan of hedging, I think that at around 60c and a TWI near 50, the risk/return trade off favours the adoption of a hedged strategy. This isn’t always readily available, but if I was investing additional dollars and had the choice of a hedged or unhedged option, despite the higher costs and sometimes poorer liquidity, I would take the hedged option.
Should you still invest offshore?
Investors with a balanced risk profile would typically have 20% to 25% of their investment portfolio offshore, while growth-oriented investors might have more than 30% allocated offshore. If your well below these weights, I can’t see any reason not to continue to invest offshore.
While Australia has done better than many countries at managing the Covid-19 crisis and this could help in the recovery, some of our major export industries (education, tourism and resources ex iron ore) face a challenging future. I think it is premature to say whether Australia will do better or worse as the recovery gains momentum.
The only thing that has changed has been the fall in the Australian dollar (which has supported the “Investing offshore thesis”). From a risk/return perspective, a hedged approach is favoured going forward.
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 regard to your circumstances.
