Did you know that there are other countries in this world than just Australia? I’m sure you do. However, for some reason, investors don’t seem to grasp this fact and have 100% of their share portfolio invested in the ASX.
Don’t get me wrong, I have no issue with the Australian share market, but international diversification can be a very profitable way to invest and in fact help you to diversify your portfolio even further.
The graph below compares the performance of the S&P/ASX200 (Australia), with the S&P 500 (USA) and the DAX (Germany) since 2013.
The Australian stock market is indicated by the blue line and it is quite clear to see that the local market has significantly underperformed in the past three years. There is obviously no certainty that this trend will continue, but it simply emphasises that there are many opportunities for investors around the world.
Australia represents less than 3% of global equity
Most Australian investors have most of their portfolio invested in Australian blue-chip stocks. Our market is known to be a high-yield market, as companies pay attractive income on a consistent basis.
While Australia is home to a dynamic and large stock market, on a global scale, it represents only a small fraction of investable global equities. According to the S&P Global BMI (Broad Market Index), Australia represents less than 3% of total equity, which appears reasonable considering that this country has a population of just over 23 million. This is just 0.3% of the total world population.
Australia is heavily weighted towards financial and mining stocks
As of April 2016, nearly 50% of the companies in the ASX200 belong to the financial sector. The second biggest sector is Materials & Resources, making up roughly 15% of the total index. Information Technology is the smallest sector, representing just 1% of the total market.
In the U.S. information technology is the largest sector making up ~20% of the S&P500, closely followed by Financials (16%) and Health Care (15%).
Every economy has different characteristics, hence the composition of local stock markets differs significantly. Overseas markets may offer you access to sectors that are poorly represented in Australia, e.g. as outlined above, information technology is relatively underweight in Australia compared to the U.S. stock market.
Some of the biggest companies are listed overseas
Google, Facebook, Apple, Allianz, Adidas or Nike are just some of the major companies listed on overseas markets. There is a reason why these companies are known to everyone, as they have obviously done something better than other companies.
While Australia certainly has exceptional local companies with a global presence, most major brands are listed elsewhere. By opening up your scope to overseas investment opportunities, you simply increase your possibilities.
Risks of investing overseas
In addition to the general risks associated with investing in stocks (yes, that exists overseas too), there are additional risks that should be considered before buying international shares.
The international investment is typically held in the respective local currency, which means your investment is subject to foreign exchange movements. If the currency of your international investment depreciates in value, you may encounter subdued returns in AUD terms or vice-versa. However, the foreign exchange impact is only realised when you sell equity and transfer it back into Australian dollars.
Furthermore, there are sovereign risks for investing overseas and local investors may not understand relevant foreign policies or the economy as much as they understand the local market. While international markets are often trading while you are asleep, you may not be able to react quickly to price-sensitive announcements.
Many of the largest online brokers in Australia offer easy access to overseas markets such as USA, Germany, Hong Kong or the UK. In most cases, you have to simply open an international share trading account and you are good to go.
Investing in international markets has numerous benefits as outlined in various research notes over time. I believe too few Australian investors have considered international diversification, even though it is a great way to diversify your risk and grow your returns.