With the Aussie dollar having pulled back to buy around US$1.03 and the outlook for commodity prices arguably a little softer than six months ago, is now the right time to invest offshore and, if so, what is the best way to do it?
There is an old economists’ joke about the direction of the little Aussie battler and it goes like this: “I am very confident that it will either go up, go down, or be about the same.” While this doesn’t inspire much confidence in economists’ predictions, let’s go with the flow and accept that almost every economist thinks that the Aussie is overvalued, and in the long term, it will revert closer to its post-float mean of around 80 US cents. To put a little context on this, it was only four years ago in the heights of the GFC that the Aussie dollar sunk to as low as 53 US cents.
Enter the big wide world
So why should your fund invest offshore? The most obvious reason is that there are many more investment opportunities compared with our narrowly focused local options. To demonstrate this narrowness, compare the relative weightings of the 10 standard equities GICS (Global Industry Classification Standard) sectors in Australia and the United States.
The Australian equity market is massively overweight financials and materials and massively underweight IT stocks. We simply don’t have the Apples, Googles, Microsofts or IBMs that the US market has – or for that matter, industrials like GE, energy companies such as Exxon Mobil or Chevron, or healthcare companies such as Johnson & Johnson or Pfizer.
How to invest
Starting with the direct option first, buy the foreign shares through your broker. Most of the major online and advisory brokers offer this service, with some providing online trading and night phone desks to service orders. We reviewed the major online services from CommSec and ETrade in February in How to buy Facebook and other international shares [1].
Another option is to buy exchange-traded funds (ETFs). There are now 21 listed ETFs on the ASX specialising in international shares, ranging from sector specific ETFs such as the iShares S&P Global Healthcare (ASX:IXJ), country/emerging markets ETFs such as the iShares MSCI BRIC Index Fund (Brazil, Russia, India & China – ASX:IBK), to the more broad-based funds such as the iShares US S&P 500 (ASX:IVV).
Our ETF ‘guru’, JP Goldman, reviewed these in December in The best ETFs for international exposure [2]. Of the major broad based funds, he favoured iShares S&P 500 (IVV) over the Vanguard US Total Market Shares ETF (ASX:VTS) for exposure to the US market, and Vanguard’s All World ex US ETF (ASX:VEU) for exposure to the rest of the world.
The following table shows the major ETFs, their MER (Management Expense Ratio), funds under management and average bid/offer spread as a percentage of their trading price.
Finally, there is an abundance of managed funds, both actively and passively managed. Vanguard is the leader in the passive (index) style managed funds. Its flagship fund, the Vanguard International Shares Index, is indexed to the MSCI ex Australia and is almost $3.6 billion in size. For a direct investment of $500,000 or smaller through a platform, the MER of 0.36% is starting to look a little pricey compared with the ETFs. On the active side, with their much higher MERs, one fund I like is the Walter Scott Global Equity Fund, which is available through Macquarie.
To hedge or not to hedge?
The two funds and all of the above ETFs are unhedged (that is, fully exposed to the vagaries of the Australian dollar). Many of the managed funds available are hedged, so deciding whether to invest in a hedged or unhedged investment is a critical decision.
In recent years, there has been a strong tendency for the Aussie dollar to rise or fall as the US market goes up or down, meaning that many hedged offshore investors have ‘enjoyed’ negative investment returns; that is, what they have made on the appreciation of the US stock market since the lows of 2008, they have more than given back on the appreciation of the Aussie dollar versus the greenback. My inclination is to back the economists and accept the widely held view that the Aussie will fall over the long term. However, investing unhedged may not always be a smooth ride.
Taxation
Income earned or attributed from offshore investments is of course taxable income in Australia. If investing directly in US shares, ETFs and in some managed funds, you may need to confront the US Internal Revenue Service’s dreaded W-8BEN form. Briefly speaking, this will ensure that a withholding tax of (only) 15% will be applied to distributed income.
For funds in the accumulation phase, the withholding tax shouldn’t be too much of a deal, as it is an allowable tax offset (that is, the Australian Tax Office (ATO) will reduce your net tax payable by any foreign tax paid). For funds in the pension phase, the news isn’t so good; as there is no tax to pay on the fund’s assessable income, there can be no tax offset. That said, as the average dividend yield in the US is around 2.2%, it is probably not a showstopper.
The bottom line
I think it is time to think hard about investing offshore. While I would love to uncover the next Apple, Facebook or for that matter, GE, I am not sure I have the patience to develop a moderately diversified portfolio of overseas shares. I am going to stick to the ETFs.
Important information: 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. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
Also in the Switzer Super Report
- Peter Switzer: Should we sell up now? [3]
- Lance Lai: Chart of the week: accumulate Telstra on the dips [4]
- Rudi Filapek-Vandyck: The broker wrap: only one company rated Buy [5]
- Tony Negline: Three foolish SMSFs and their punishments [6]