If you're like most Australians, you love to travel. And increasingly, we're also looking overseas for shopping, either online or in person. Yet when it comes to investing, we tend to stick to home.
While it's true that investing offshore can have its challenges, there are also good reasons to consider diversifying offshore, especially at a time when the Australian dollar is near record highs.
So here are some of the benefits of seeking out investments from around the world, plus some pitfalls to watch out for.
Why go offshore?
We all know that diversification is the key to managing risk while tapping into new opportunities for growth. And there are few better ways to diversify than to add quality overseas assets to your investment mix.
Investing overseas gives you access to economies with different industries and different economic cycles to our own. And even though Australia has been relatively well insulated from the European debt crisis, it won’t always be immune to a downturn. However you can insulate part of your portfolio against the risk of a domestic downturn and enjoy the growth potential of faster-growing economies and industries in other regions.
Australia's share and bond markets have a history of delivering healthy returns to investors over the long term, but they also have their limitations.
Take our sharemarket, for example. It's heavily weighted towards just two sectors: the banks and the miners. Together they make up 45% of our sharemarket (represented by the S&P/ASX 200 Index). So even a diversified investment in the Australian market is likely to be heavily skewed.
But by investing overseas, you can access industries that are under-represented at home — industries like information technology, healthcare, defence and aeronautics. Healthcare makes up less than 4% of our S&P/ASX 200, but is almost 12% of the US S&P 500. Similarly, Information Technology is less than 1% of our market, but around 20% of the US market, which includes world-leading companies like Apple, Google and Microsoft. So if you'd like to benefit from the potential of a company like Apple, you may have no choice but to go offshore.
More growth potential
Our economic growth rate may currently be the envy of the developed world, but it pales in comparison to the fast-moving economies of India and China. By investing overseas, you can tap into the staggering growth potential of emerging economies like these.
More buying power
While the Aussie dollar has fallen back slightly from last year’s highs, it's still at historically high levels.
However, it could be a mistake to assume our dollar will stay high forever. It could fall back further or it may go even higher.
They're some of the advantages, but what about the pitfalls?
One important issue you need to consider is the impact of exchange rates. The Australian dollar is one of the world's most widely traded currencies, often used as a proxy for commodity prices and risk in general. So when the market's risk appetite is strong and sharemarkets are rising, the dollar usually rises. But when its taste for risk falls, so does the dollar.
For Australian investors, that has both advantages and disadvantages. Lately our soaring dollar has created some amazing bargains for shoppers and investors alike. But an unexpected rise or fall in the value of the dollar could either cost you money or give you an unexpected windfall, depending on whether you're buying or selling.
Ups and downs
When you're investing, a higher dollar works in your favour. For example, if you'd invested AUD$10,000 in theUSon 29 July 2011, when the Aussie was at its height, you would have been able to buy US$11,028 worth of assets. But if you'd invested just two months later on 5 October, you would only have bought US$9,478 worth — 14% less.
When the time comes to redeem your investments, it works the other way around. So, if you had sold a US$10,000 investment on 29 July 2011, when the Australian dollar was soaring, you would have received 14% less in Aussie dollar terms than if you'd waited until 4 October, when our dollar had fallen back.
Investing with protection
So how do you protect yourself against currency fluctuations like these?
One of the easiest solutions is to invest in a fund that uses currency hedging to reduce the impact, or even remove it.
A fund that’s hedged uses currency contracts to remove the risk of the Australian dollar rising, but at a cost. A partially hedged fund gives you partial protection from a rising Australian dollar, while leaving open the possibility of profiting if the Australian dollar falls. Unhedged funds are popular at present with investors who see a longer term decline in the Australian dollar back towards historical averages, or for those who see increased risk of short term market volatility when the US dollar tends to outperform.
With dozens of international funds and investments to choose from, it’s a big world out there. So it makes sense to get specialist advice from an expert before you invest.
The key is to understand the issues beforehand, read the fund's Product Disclosure Statement carefully and talk to your financial planner.