When you’re searching for a job, do you only apply to just one company? When you are thinking of schools for your kids, do you register at just one? Most people will keep their options open. Investing is no different. You shouldn’t be putting all your eggs in one basket.
Diversification is one of the critical factors to consider while putting together a robust and well-balanced investment portfolio. Diversification is more likely to produce stable portfolio returns with reduced volatility than a concentrated portfolio.
So, along with owning Australian shares, investing in international shares is a good idea as well. Here are three key benefits from investing internationally:
- Portfolio Diversification
- Access to new and innovative companies across diverse industries
- Exposure to high growth markets and companies
And two risks you need to be mindful of:
- Currency swings
- Geopolitical tensions
Benefit 1: Diversification
This goes back to the “don’t put all your eggs in one basket” argument. Australia was relatively sheltered from the impact of the global financial crisis in 2008, a fact which is also reflected in the equity markets. Equity market performance has been driven by demand for commodities, strong housing sector activity and positive consumer sentiment. This simply means that by spreading your investment across different markets, where you don’t gain money in market, you could make up for it in another.
For example, in 2014, if you were invested purely in Aussie equities, you would have made a return of +1.1% and missed out on more favourable returns elsewhere. In AUD terms, the US market (as measured by the SP500 Index) returned +21.8% and the global market (as measured by MSCI All Country World Index) gained +13.5% during 2014. In other words, these markets performed better than the Australian market and had you of invested purely in Australian equities you have missed out on a world of opportunities. Owning international shares of companies in the US, Europe, Asia and emerging markets provides more breadth to your portfolio. This helps you diversify your portfolio returns and reduce risk from concentrating on only one market.
Benefit 2: Access to new and innovative companies
While there has been a recent wave of new technology companies listing on the ASX, we still have some ways to go before we catch up with the likes of Silicon Valley in the US or the high tech industry in UK. The quality blue chip companies in Australia tend to be concentrated in a few sectors like Mining, Banking or Consumer. However, investing in international shares opens up the ability to buy into companies further along the innovation curve. For example, you could look at healthcare companies doing cutting edge research on developing diabetes drugs like Novo Nordisk or technology companies like Google or Apple who are constantly coming up with innovative new products and services. The list does not stop at Healthcare or Information Technology though. You can find emerging innovative companies in Energy (think solar, wind and alternative energy), Industrials (high tech manufacturing) or even traditional sectors like Utilities (efficient water storage and management etc.)
Benefit 3: Exposure to high growth markets and companies
Australia is a mature developed economy with a fairly saturated market in most products and services. While we enjoy a high standard of living with one of the highest GDP per capita around the world, this also implies a limit to how fast our markets or companies can grow, particularly the ones focused locally. In contrast, in a number of economies in the developing world (emerging markets like China, India, Indonesia and other countries in Asia and Latin America), companies are not only growing top line revenues at a much faster rate but also enjoy higher profit margins. It would be a shame to miss out on such growth opportunities – whether it is in IT in India (the likes of Infosys and TCS) or South-east Asian healthcare (IHH Healthcare) or luxury goods in China (Chow Tai Fook).
While international investing has significant advantages, it also carries certain risks. The first and foremost is the currency risk. Any investments you make in shares of companies listed in international exchanges will be in the local currency. But when you sell your investment to realise returns and repatriate it, your return will incorporate any currency fluctuations as well. For instance, if you had invested in the SP500 in the beginning of 2014 and sold out of it after one year, your investment would have gained +11.4% in US dollar terms, but since the AUD has depreciated relative to the USD, your return is much higher at +21.8%. Thus, currencies can provide a boost to your international investments, but on the flip side can also prove to be a headwind if they move against you.
The second major risk in international share investing is geopolitical risk. This is relatively low when investing in stable developed market economies, but could prove to be significant in the case of developing countries. For instance, the equity market in Thailand underperformed during periods of political unrest in Thailand in recent times. There are significant benefits to investing in international shares, including providing an opportunity to diversify one’s portfolio and access to exciting new and innovative companies and industries across the world. There are risks we all need to be aware of, however by weighing up the risks and the benefits and making a decision that aligns with one’s personal situation, may result in some great returns and successes. Happy investing!
“This article is not financial advice. If you seek advice specific to your circumstances you should consult a professional adviser.”