The guide to offshore investing
Australia has had the best performing stock market in the world over the last decade. Over the next decade it may not be as easy to generate such strong returns.
The Australian share market has become very concentrated, and is dominated by two industries, financials and resources, which are highly correlated. Today, these industries either look expensive or risky, which is why investors are gradually beginning to look offshore. The elevated Australian dollar and lack of diversification in self-managed superfunds further enhance this need. This article will give you the tips of when, where and how for offshore investing.
When is the right time?
The rules to investing are pretty straight forward, buy low and sell high. The Australian market appears expensive and opportunities are limited. Australia’s big banks have soared to become some of the most expensive in the world by nearly every measure, and the International Monetary Fund recently released results indicating Australia may have the world’s second-most expensive housing market behind Belgium. This exposes the near 50% financial sector of the Australian market as highly priced. When we turn our attention to resources, as China’s economic growth slows it puts pressure on resource stocks. This means that the two largest industries in Australia which occupy well over 60% of the index provide futile ground for new investment. When we look to the world index not only do we see more value in these sectors, but we are able to gain exposure to industry sectors which are not well represented here in Australia. For example, try finding a Google or Apple in Australia; in fact, Information Technology as a sector represents a mere 1% of the ASX 200 Index.
Another consideration Australians must consider is the high trading value of the Australian dollar. The key drivers of the Australian dollar are interest rate differentials and commodity prices. Commodity prices in Australia are driven by demand from China. Due to the slowing economic growth in China it has meant key commodity prices have contracted by up to 30-40 per cent. Economically this should be reflected in a contraction in the Australia dollar. The reason we have not seen this is due to interest rate differentials.
Interest rates are driven by the Federal Reserve (“Fed”), the central banking system of the United States. The Fed has kept interest rates at near zero for an extended period, and although interest rates in Australia are at absolute lows, on a comparative basis to the rest of the world they are actually at highs. When the Fed stops intervening and allows rates to rise naturally, this interest rate differential between Australia and the United States should close, as the economic outlook for the US continues to show signs of improvement whilst the contrary is showing in Australia. This should cause the Australian dollar to reflect the abovementioned contraction in commodity prices and thus, depreciate relative to the US dollar.
By exposing your investment portfolio to overseas currencies which have the capacity to appreciate relative to the Australian dollar, investors can potentially enhance their returns.
Another rule of investing is to invest in what you understand. Australians have followed this rule, perhaps a little too closely. We hear about the large Australian companies consistently. We shop at their stores, regularly see their advertisements, read about them in the paper and thus, we are familiar in their brand names, so the thought of investing in them is less daunting. Offshore companies, we often know and understand less and therefore we have avoided investing in them. Australia’s share market represents less than 2% of the world’s companies yet Australians have more than 71% of their assets in Australian investments.
This makes little sense. One of the first concepts you learn when studying investing basics is diversification, which is an effective way to reduce risk by spreading your exposure. If you hold a diversified portfolio with a variety of different investments, it is much less likely that all of your investments will perform badly at the same time. Diversification enables you to reduce the risk of your portfolio without sacrificing potential returns.
So when we combine the fact that the assets we hold the most of appear expensive, with the elevated currency, it would suggest that now is a good time to start moving assets offshore.
Need to look at the glaring valuation anomalies
As we mentioned above, it is much easier and comforting to invest in assets you know and understand. Globally there are so many assets it can become mind boggling. Yet investors should apply the same basic principle; buy low, sell high.
The difficulty with buying low is fear. Fear has a way of gripping the market, leading investors to cling together and suffer from inferior investment returns. Despite a familiar pattern of how genuine long term valuation anomalies play out over time, it is the same issue that prevents the majority from taking advantage of opportunities; the fear of being seen to be different from the rest of the crowd. In fact, this is one area where the market has actually regressed over time. Such fear has never been stronger and unfortunately it is a recipe for sub-standard investment results.
However, this fear feeds opportunity. The opportunity lies where no one else is looking. Opportunities in the market come from identifying long term valuation anomalies that arise from either a severe cyclical event that is transitory in nature, or business qualities that are simply under-appreciated by a market that is typically pre-occupied with short term macroeconomic noise.
Investors who have done well over the past twenty years, have taken advantage of the opportunities created by market events, including the Savings and Loans Crisis in 1990, the technology crash and commodities boom in 2000, the US housing recovery via US property and retail banks in 2009.
It requires a certain degree of bravery but investors must try and look forward, not back, and be brave enough to shake the tree so that their investment control processes are ahead of the curve and not behind it.
We are finding these opportunities currently in areas of the market that are severely depressed. The US housing market is one clear example of this. Valuations have begun to recover from the lows during the Global Financial Crisis, however they are still operating under industry conditions that are well below normalised levels, yearly sales are still at least a third below normalised trends, and there is a strong prospect of solid earnings growth looking forward, which will drive further valuation expansion. Europe, in particular countries like Spain and Ireland provides additional examples yet they are further lagging the recovery process, and thus present an even more compelling opportunity. When you go shopping and you know there will be a similar product sold next door 40% cheaper, generally you’d be crazy not go next door to buy it. This is how we view the equity market. Australian property is trading at highs, yet we look overseas where they are selling at over 40% discounts, we think it would be crazy not to ‘shop’ there.
So how can Australians access this opportunity? There are in fact a few options for Australians to invest offshore. Australians can invest in direct equities via online brokers or find a specialist in international equities that will buy and sell shares or other assets on your behalf. PM Capital offers the ability to invest in global equities via either an unlisted managed fund or a listed investment vehicle, which trades on the ASX like an ordinary stock.
How much do you have invested offshore?
Content is provided by Livewire Markets and does not represent the views of AMP Capital.