We often talk about diversification of investments. In our country, we are ‘triple exposed’ to the Australian economy. What we mean by that is the majority of people live, work and own property in Australia – meaning that if there is a downturn in the Australian economy, we are affected by it in three ways.
When it comes to super funds and investments, Australian companies primarily sell products and services to Australian consumers. Again, if your investments are limited to Australia, then this can be a risk.
Australians frequently talk about having diversified investments, but they usually mean national diversification. For instance, they may be invested in the top 200 companies of Australia, or own a property in Townsville as well as Brisbane.
This can seem diversified – but it’s not diversified enough. Like everything, people tend to have a home bias. All countries do – citizens feel more comfortable investing in the companies they know, trust or have worked for.
But no geographical region is immune to changes or drops in the market. So how do we diversify to make the most of our money? One way is to invest globally. Then, when there is a drop in one market, your investments will be balanced out by the others that are doing well. It’s actually not that difficult to invest in the top 1,500 companies around the world, tracking with the MSCI world index for example. Nor is it expensive to do this – some fund managers out there do it for 20 basis points which is 0.2% – so $2,000 for every million dollars invested. And it’s cheap considering they're converting your Australian dollars and investing them around the world.
To use a sports analogy (one of our favourite things to do!) – a global market is like a worldwide football competition. It doesn’t matter how strong one team is – in any competition, there is always a winner and always a loser.
There are two ways to be invested in overseas companies. One is to be hedged to the Australian dollar, which doesn’t allow currency fluctuations to affect your investments.
The other way is to be unhedged which means any fluctuation of currency will affect overseas investments. Anytime you invest in overseas companies you're actually converting your Australian dollars into those currencies before buying the shares. To give you a real example, if we go back and look at the Australian dollar compared to the US dollar back in 2013, it was almost 1:1. So if you invested $100,000 AUD, you would have $100,000 USD. Because our dollar has since fallen in relation to the USD, that would convert to around $135,000 AUD now – a 35% rate of return in the currency movement. But the same goes for the alternative – you can lose money if the Australian dollar rises. That can be avoided by hedging, of course, but there is an extra cost to that and usually isn’t worth it.
Our thought is that because we live, work and own property in Australia, we want to protect against a drop in the Australian market. For that reason, being unhedged to the Australian dollar is better in our opinion. It’s not that simple, of course – investing is complex. If we could guarantee that over the next 30 years all overseas markets as well as the Australian market would have an equal return of 8%, then of course we would recommend only buying Australian shares. Another benefit to Australian shares is that they come with franking credits which add about 1% to your return when you consider the tax benefits, giving you a 9% return overall.
Nobody can predict that, though (although it would be great to foresee the future!).