The case to buy international shares is strengthening as the Australian dollar falls, the United States recovery firms, and Japan awakes from its economic slumber.
The Australian dollar has tumbled from almost US$1.06 in early January to about US98 cents. Stronger demand for the Greenback, expectations of lower interest rates in Australia, and weaker commodity prices are pushing our dollar low. It could slowly head towards US90 cents.
Predicting the Australian dollar’s value is, of course, fraught with danger. Everybody knows our currency is overvalued, but it has stubbornly refused to trade well below parity with the Greenback. Australian investors who held international equities, and were unhedged for currency moves, suffered.
Overseas shares (unhedged) were the worst-performing asset class over 10 years to June 2012, the ASX / Russell Investments Long-Term Investing Report shows. They returned negative 3.1 per cent annually, less than the 3.8 per cent annual cash return, and over 20 years were only slightly ahead of cash.
By any measure, overseas shares were a train wreck for local investors who held them directly or through unit trusts, and were exposed to a rising Australian dollar. When global sharemarkets fell during the Global Financial Crisis, and our dollar rose, investors copped it at both ends.
History, at least, shows the worst-performing asset class is often among the best in the following decade. That could be the case for international equities if the Australian dollar continues to ease, US sharemarkets keep rising, and more funds flow to their natural currency: the US dollar.
Long-term investors, such as Self-Managed Superannuation Funds, should consider increasing the international equities component of their portfolio (within the equities allocation), or talk to their adviser about this strategy. Plenty of gains are ahead if the Australian dollar falls further.
The strategy should have three parts. First, stick to funds that are unhedged for currency movements. Although the Australian dollar could hover around parity with the Greenback, the odds favour further weakness as the resource investment boom peaks and interest rates are cut a few more times.
Second, focus on owning regions or countries rather than buying shares directly. Choosing undervalued US shares, for example, makes sense if you have a strong view on a particular company. But the strategy outlined earlier is about tactical asset-allocation shifts rather than choosing individual overseas shares.
My preferred country themes are the US and Japan. Europe is still a mess, China’s prospects are uncertain, and it is too early to add more emerging markets. Having run hard over 12 months, US shares are due for a pullback or correction, which could be an ideal buying opportunity.
Although US equities look fully valued, the long-term prospects for the US economy and its sharemarkets are bright. Shale gas is a game-changer that will eventually make the US energy self-sufficient and give its manufacturing sector a huge competitive boost thanks to falling energy costs. The next game-changer, three-dimensional printing, is also gaining traction in the US.
Japan, too, has rallied this year after unprecedented quantitative easing from its central bank. The Nikkei 225 Stock Index has soared from a 52-week low of 8,238 points to 15,627, in one of the more remarkable sharemarket rallies. Like the US, Japan’s sharemarket is due for a pullback.
But after a 23-year bear market, the rally in Japanese shares has a lot further to run over the coming decade.
The strategy’s third part is owning global equities through a fund: an exchange-traded product (ETP) for low-cost index exposure, or a unit trust or Listed Investment Company (LIC) for active exposure.
The iShares Core S&P 500 ETP and iShares MSCI Japan ETP are good choices. Both have minuscule annual fees and are a simple way to lift exposure to US and Japanese shares in portfolios, via the Australian Securities Exchange. They are unhedged for currency moves.
International LICs are an interesting option for investors seeking active exposure to offshore markets. Some are trading at significant discounts to their net tangible assets (NTA), but may offer broader exposure to international markets than just a US or Japan focus.
For example, the AMP Capital China Growth LIC traded at a 23 per cent discount to pre-tax NTA at April 2013, ASX data shows. The Hunter Hall Global Value LIC had a 15.7 per cent discount, and Platinum Capital traded 5.2 per cent below NTA. The Templeton Global Growth LIC had a 12 per cent discount.
Rising demand for overseas shares could lead to a narrowing of discounts for international LICs, and amplify gains for those who gain exposure via LICs trading below their asset backing.
However, investors who want pure exposure to US and Japanese markets, are happy with the index return, and expect our dollar to fall, should stick to low-cost ETPs.
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Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at Feb 14, 2013. The author implies no stock recommendations from the above commentary. Readers should do further research or talk to their financial adviser before acting on themes in this article.