I think I mentioned in a previous episode that I’ve been doing a lot of research recently on a possible new book I’m working on focused on investment portfolio construction and evidence based investing. One aspect that’s cropped up is the question of how much international share exposure we should have in our Australian portfolios. If you’re in a default balanced fund option, then this decision will be made for you. But those listeners who break down their superannuation and investment portfolios into different investment options will have faced this dilemma.
This week I wanted to share with you some of the things I’ve learned and my current thoughts. My thinking in this area is still a work in progress, and I’m continuing to read and learn. Hopefully though, these musings might help you find a workable path.
Most of us, when we start investing, will buy Australian shares. We typically gravitate towards businesses that we recognize, perhaps one of the miners, a bank, or a retailer that we walk past at the local shopping centre. Before long we stumble across exchange traded funds, and most people tend to gradually invest more and more in these vehicles over time due to the lower level of mental energy required in making the investments, and their significantly lower level of volatility.
You’ll probably start with an ETF covering the Australian market, but it won’t take long until you are casting your thoughts more broadly and ETF’s covering international markets become a consideration. At some point you’ll reflect on the proportion that should be directed to these international markets relative to the proportion that you retain in Australia. Having had the privilege of reviewing prospective clients portfolios over many years, I typically see the Australian share component of people’s portfolios representing 60%-100% of their holdings. Rarely do international share exposures comprise the majority of a portfolio.
Having a home country bias within portfolios is not something unique to Australia. Almost every country in the world sees the same thing. In some cases the portfolio bias can take on a degree of patriotism.
My question though is whether as investors, aiming to grow our wealth and in so doing achieve the choice and flexibility that enables us to lead interesting lives, this bias makes sense?
One reason for the comfort with regards holding Australian shares is the regulatory security. Here in Australia we can have confidence that if someone does something shonky, there will be government agencies that have our back and give us some level of protection. That can’t be said for investments made in other jurisdictions or things like cryptocurrencies.
Via ETF’s, and managed funds for that matter, investors can gain exposure to international markets using products that are listed and regulated in Australia. The logic therefore that an investor has greater security by holding an Australian share fund relative to an international fund is false. Now clearly that’s not to say that the underlying investments necessarily have the same level of risk. But the investor can certainly take confidence from the fact that their ETF must satisfy the scrutiny of the Australian Stock Exchange, hold a financial services license, and meet the various other regulatory requirements.
Investing in Australian domiciled funds, whether they hold domestic or international securities makes no difference to their level of safety.
Another reason for favouring domestic equities could be concerns around exchange rate exposure. In buying international shares, we become exposed to changes in the rate of the Aussie dollar relative to the rate of the domestic currency in which the stocks that we’re buying are listed.
My view on this is that for long term investors the impact of exchange rate movements tends to balance out over time. Sometimes the exchange rate will move to your benefit, and other times it will move against you. Over the journey, in my experience, the impact is not meaningful. If it’s something that you are particularly worried about, many funds offer a hedged version, which means they take out a form of insurance to eliminate currency fluctuation. This insurance of course costs money, so the management fees on these funds tend to be a little higher. But if exchange rate fluctuation is of concern to you, be aware that this solution exists. For some clients we would allocate 20-30% of their international exposure to hedged options as a way to manage exchange rate risk.
So far we’ve considered reasons why people might be inclined to favour the Australian stock market, but increasingly I’m thinking about why we shouldn’t.
As Australian residents, we have significant exposure to the Australian economy simply through living our lives. All our savings are in Australian dollars, we pay Australian taxes, receive Australian services, have Australia’s Social Security infrastructure. Our government ‘s budgets are driven by the success of our largest companies, who pay taxes, royalties, and employee hundered of thousands of us, resulting in the collection of income tax. In short, simply by living in Australia we are highly exposed to Australian business and it’s listed stocks.
Take a moment to imagine that instead of living in Australia right now, you are living in Argentina. In the early to mid 1900s, Australia and Argentina where economically equivalent. Similar populations, similar living standards, and similar economies with agriculture and resources large contributors.
In 2023, inflation in Argentina hit 161%, eviscerating Argentinians savings. It’s currency lost about 90% of its value relative to the US dollar. One in four Argentinians live in poverty today.
If you lived and worked in Argentina for the last 50 or 60 years, and patriotically put all your retirement savings into Argentinian investments, you would be distraught. Had you had the opportunity to instead invest in United States stocks, or indeed other developed nations, the savings you’d accumulated through all those hard years of work would be preserved, and you and your family would be financially secure.
Now I’m certainly not suggesting that Australia faces anything like Argentina’s fate. But this extreme example highlights why my thinking is increasingly turning to having portfolios strongly biased offshore, primarily in the United States. From a diversification perspective, it appears irrefutably prudent, particularly given we can achieve this diversification via domestically regulated investment structures.
My primary reservation is an awareness that I could be suffering from recency bias. This is the behavioral economics phenomenon seen when our decisions take into account recent events disproportionately to the longer term experience. As you will know if you get the GainingCHOICE e-mail each week, the US stock market has performed far better than our local market over both the past year and the past five years. The difference between the two is not minor. Am I therefore arriving at this allocation preference due to these results?
It’s for this reason that I intend to do more research. But at this point it seems to me to be more of a removing of the blinkers. I’ve always advocated meaningful allocations to international markets. But we’d still tend to have 20-40% of holdings in Australian shares. Now for retirees in particular that might remain optimal because of the income production of Australian shares and the extremely generous franking credit treatment. But for growth investors, who are the bulk of the Financial Autonomy community, you’d be much wealthier today if you’re invested in the US stock market than the Australian stock market over the past decade.
This result has largely been driven by the performance of the tech sector in the United States. For this outperformance to not persist into the future then, you would have to have a view that the tech sector is likely to underperform in the years ahead relative to sectors like mining and banking, that are so dominant on our local market. Personally I find it hard to envisage this outcome, but like you, I don’t have a crystal ball, so who’s to know what the future holds.
Take some time over the next few days to think about how you allocate between Australian and international shares in your investments. Does the split make sense? Have you actually got enough exposure to Australian business already in your life, such that it would make sense for your investments to be elsewhere as a diversification and risk management piece?
I’d love to hear your thoughts on this topic. Reply to a recent GainingCHOICE email with your thinking and observations. If you’re not currently receiving the GainingCHOICE weekly e-mail, you can add yourself to that list for free here. In that e-mail I provide a market update to keep you abreast of what’s going on in the investment world.Back to All News