The thought of investing into overseas companies or assets can be quite daunting for many. Overall, there tends to be a "home field" bias for most investors, with the inclination to keep investments domiciled locally, and only venturing internationally as a last resort. This seems to be mainly driven by the higher level of comfort one might have for domestic companies and governments, with many investors wanting to invest only in assets (shares, property, bonds, etc) in which they have a good understanding of the underlying business or environment, which tends to mean local company shares, property and government bonds. This attitude, however, can have large and adverse effects on portfolios with greater risks and lower returns.
So why invest overseas?
(1) Lower risk environment - Local investors often feel as though investing into International markets will automatically come with higher risks. This perception is likely driven by fear of the unknown, and in most cases it is often incorrect. For Australian investors, finding lower risk environments might seem difficult, but in analysing the vast array of investment markets around the world, it is not hard to find businesses and assets that would tend to be much more protected from swings in prices and potential for permanent loss of capital. Believing that Australia, which accounts for about 1% of global GDP, has a monopoly on secure investments would be foolish. It is much more likely that one would find lower risk assets and environments internationally rather than inside of Australia.
(2) Diversification benefits - One main way to reduce risk in a portfolio is to increase the amount of diversification - i.e. investing in different companies, different industries, different asset classes and different countries. The major benefit of this is the reduction in idiosyncratic risk, or the risk that your investment selection suffers from plain bad luck (i.e. unforeseen events with adverse consequences). Diversification benefits can still be achieved when investing entirely in the one country, and Australians can gain a good spread of investments by looking locally. However, there are two areas where Australia-only investors will fail to gain a good mix of assets - industry diversification and country diversification.
For all that Australian business has to offer, there are still a few industries that are not well represented on the ASX. This includes technology stocks (Apple, Google, etc), auto stocks (Toyota, General Motors, etc) and energy stocks (ExxonMobil, BP, etc) with other sectors such as consumer goods, food and beverage and defense also under-represented. The majority of Australian shareholder wealth is tied up in the banking oligopoly, supermarket duopoly and mining behemoths, though the healthcare sector is one bright spot for diversification. However, to get access to some of the other major business sectors, it is necessary to venture offshore.
Australia-only investing also opens the door to country-specific risk, that is the risk that something unforeseen happens to Australia. Though this is usually not that big of an issue for developed economies, there are occasions where events (especially natural disasters) could cause adverse consequences for the one country or region. This occurred most recently in Japan, with the 2012 earthquake and tsunami hitting the Japanese economy, but has also been seen here in Australia with floods and cyclones causing much loss of business over the past few years.
(3) Currency - risk or reward? - One argument put forward in the case for international investing is the potential benefit of currency. For Australian investors in particular, the currency is seen as an added diversification tool in helping to reduce the risk of investing overseas. This is due to the perceived, correlation between the Australian dollar and International market returns - i.e. when international stocks go down, international currencies tend to go up. This can provide a buffer against poor share market returns. However, this can also limit the upside potential that might otherwise be achieved (e.g. 2003-2007).
(4) Returns - Over the long term, Australian investors have been treated well in regards to share market returns. Looking over 30 year, 50 year and 100 year returns, Australian equities have outperformed most other developed equity markets. But this outperformance is not necessarily true for shorter periods and may not be true into the future. A look at the last 5 years has seen the Australian share market barely provide much more than inflation, whilst equities in the US, Japan and Germany have doubled.
There is always the case for having a preference for domestic assets over international assets. For example, rules and legislation around property investing make it easier to buy an investment property in your own country rather than overseas (not to mention easier tenant management, ongoing property maintenance, etc). Also, the benefit of the franking credit system in Australia, should provide an incentive for Australian investor to focus more on domestic companies. However, the added risks through lack of diversification and the possible underperformance of returns, highlight the importance of keeping an open mind when it comes to investing globally.
LBW Financial Services Pty Limited is an authorised representative of Wealthsure Pty Ltd, AFSL 238030, ABN 93 097 405 108. The information contained within these articles is of a general nature only. Any rates (tax rates, Centrelink rates, exchange rates, etc) are correct at time of publication and are subject to change. Whilst every care has been taken to ensure the accuracy of the material contained herein at the time of publication, neither the author, authorised representative, nor licensee will bear responsibility or liability for any action taken by any person, persons or organization on the purported basis of information contained herein. Without limiting the generality of the foregoing, no person, persons or organization should invest monies or take action on reliance of the material contained herein but instead should satisfy themselves independently of the appropriateness of such action.