Self-managed super fund trustees only have 0.8% of their assets invested directly offshore, according to recent ATO data on SMSFs (see Trustees get a little more defensive [1]). This is a staggeringly low proportion, even accounting for the fact that the number likely understates the true amount due to some classification issues.
The classic industry asset allocation models target offshore weightings of around 22% for a ‘balanced’ investor through to as high as 45% for a ‘high growth’ investor. There is a problem with these models as well: they are constructed from a ‘pre tax’ perspective and don’t take into account the benefits derived from fully franked dividends that are so attractive to superannuation funds. That said, there is a strong case for SMSFs to make a material allocation to offshore assets.
Why invest offshore
The most obvious reason is that there are many more investment opportunities offshore, and our options locally are so narrowly focused. To demonstrate this narrowness, compare the relative weightings of the 10 standard equities GICS sectors in Australia and the USA.
[2]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 or for that matter, industrials like GE, energy companies such as Exxon Mobil or Chevron, or health care companies such as Johnson & Johnson or Pfizer.
Two risks to manage
Unlike local investing where you only have to consider the capital growth or income from the asset, investing offshore can involve managing a foreign currency risk. This risk can of course be mitigated by hedging.
This probably sounds pretty obvious; however, it’s surprising there is so little disclosure in the public material presented by fund managers and others about their hedging policies and for that matter, with the industry’s approach to classifying offshore assets.
Hedged or unhedged?
It’s almost impossible to find an economist or financial commentator that doesn’t believe the Aussie dollar at around US$1.04 isn’t overvalued, and in the medium term, will revert back to its post float mean of around 0.80 to 0.85 US cents. I’m in that camp as well – and this worries me, as history has an annoying habit of demonstrating that when everyone agrees that it will go one way, it invariably goes the other way!
I will stick with my view and back the conventional orthodoxy – if investing offshore, do it on an unhedged basis.
How to invest
If you know what you want to invest in, the direct option is to buy the foreign shares through your broker. Most of the major brokers offer this service, with some providing online trading and night phone desks.
Opening an offshore trading account takes a fair degree of patience and perseverance and while brokers such as CommSec have made the process as simple as they can, you will end up doing paperwork for the US Department of Inland Revenue – the notorious W-8BEN form.
Another option is Exchange Traded Funds. There are 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, to the broad-based funds such as the iShares US S&P 500 (ASX Code IVV).
These ETFs invest on an unhedged basis – that is, they reflect the underlying currency that the index they track is denominated in. On the ASX where you buy or sell the units, they are priced and quoted in Australian dollars and performance is also measured in Australian dollars.
The major broad-based ETFs are listed below, showing their management expense ratio (MER), funds under management (FUM) and average bid/offer spread as a percentage of their trading price.
[3]On a performance basis, all the major ETFs closely track the underlying index. For example, the table below shows the performance of iShares IVV ETF over one, three and five years as well as the total return of the underlying index in Aussie dollars. The differences are very small.
[4]The ETF has done pretty well over the last 12 months, moderately well over three years, and poorly over five years. Notwithstanding that the US market is close to all time highs, the Aussie dollar has appreciated over the last five years. Back in August 2007, the Aussie dollar was worth 0.8214 US dollars – so investors in this ETF have seen the sharemarket gains in the US more than eroded by the appreciation of the Aussie dollar. That’s the risk with investing on an unhedged basis.
Finally, there are a plethora of managed funds – both actively and passively managed.
Taxation
Income earned or attributed from offshore investments is taxable income in Australia. If investing directly in US shares, ETFs and in some managed funds, you may need to confront the W-8BEN form. This will ensure that a withholding tax of (only) 15% will be applied to distributed income.
For funds in accumulation phase, the withholding tax shouldn’t be too much of a deal, as it is an allowable tax offset (that is, the ATO will reduce your net tax payable by any foreign tax paid). For funds in 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’s probably not a show stopper.
Bottom line
I think it’s time to think hard about investing offshore on an unhedged basis. While I would love to uncover the next Apple or for that matter, GE, I’m not sure I have the patience to develop a diversified portfolio of overseas shares. I’m going to stick to the ETFs – the iShares IVV or Vanguard’s VTS is hard to go past.
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. Anyone should consider the appropriateness of the information in regards to their circumstances.
Also in the Switzer Super Report
- Peter Switzer: An investment doctrine for believers [5]
- Rudi Filapek-Vandyck: The broker wrap: RIO, OZL, and ORI [6]
- Lance Lai: A buying opportunity is emerging [7]