Thursday, April 30, 2009

Buying International Shares

Should Australian's buy overseas shares as part of a balanced investment portfolio?

The Australian stock market is a very small portion of the overall investment universe - less than two percent, depending upon who you listen to. So today I'm going to explore why you might like to consider investing in international shares as well as a discussing some of the options.

The reason I started thinking about this was that I was recently reading about an investment concept known as asset allocation. The idea behind asset allocation is that you spread your investments across different assets classes with different risk profiles and for which returns are not always correlated. One of the asset classes suggested by many financial planners and other investment professionals is international shares.

By buying shares in overseas companies you can gain access to some the largest companies in the world. These businesses are truly global in their operations and many produce products consumed by us all the time. These are companies like ExxonMobil, General Electric, BP, Royal Dutch Shell Group, HSBC Group, Toyota Motor and GlaxoSmithKline, just to name a handful.

But just to temper your enthusiasm for these global giants for a moment, just remember that the normal rules of stock market investing apply to these companies as well. Do your homework. While larger companies are often seen as more secure investments because of the scale of their operations, financial strength and their ability to attract the most skilled managers, it still pays to remember some of the high profile casualties of the global financial crisis. I would avoid any of the stocks with large debt burdens or a patchy history of profitability.

Another good reason to buy international shares is for exposure to some of the faster growing or emerging economies. While the risks in these areas are significantly higher, the rewards can be substantial.

How To Buy Overseas Share Investments

The most common way of gaining international investment exposure is via a managed fund of some description. Here the choices are many and varied.

You can choose a fund which concentrates on a particular region. For example, the Platinum Asia Fund invests in companies which operate in the Asian region. And BT Funds Management offer a European fund. (These are not recommendations, but rather just a couple of concreate examples.)

Another way in which the investments are divided is by industry or investment 'theme'. Examples of these might be Healthcare or Technology. These funds would buy shares in companies which operate within a particular sector of the economy.

Or if you have a relatively small amount of money to invest, or you don't feel strongly about any of the regions or themes on offer, you may want to look at a broadly diversified international managed fund which buys shares in companies all over the world. The better managed funds in this category will give you exposure to businesses in many industries across all regions of the world.

There are also a number of listed investment companies and exchange traded funds which hold internalional shares and you can buy and sell these on the Australian Stock Exchange. There are many options available here so this is probably a topic for another day. If you have any interest in pursuing this angle, have a look on the ASX website at the iShares product and also their section on Listed Investment Companies.

The last option you may consider is to buy shares in international companies directly. Many stock brokers offer international trading as part of their service. Costs are normally higher than you would pay for buying and selling Australian shares both in terms of brokerage and also their fees. However, this option is probably more suited to more experienced investors.

As I mentioned in my post on buying American shares, another factor to consider is currency risk. This is the risk that the value of the Australian dollar will change when compared to the local currency of the country in which you invested during the interval between when you bought and sold.

If the value of the Australian dollar goes up, you will receive less when you sell than you would have if the exchange rate had stayed the same or dropped. Of course the opposite is true as well. If the Aussie dollar drops, you will make more money.

Many managed funds offer a product which is hedged. This means that they will try to take currency fluctuations out of the picture (through the currency futures markets) so that any returns will be in constant dollar terms.

Last (but unfortunately not least) you will need to consider tax implications. Any dividends paid will be subject to tax under each foreign country's tax laws. Rates will vary depending on the country in question. Then the dividends would also be subject to tax in Australia. Depending on the country of origin of the income, you may be entitled to some tax relief whereby you may only be taxed on the difference between the foreign rate and the Australian rate.

Also, the franking credits available under Australia's dividend imputation system don't apply to foreign dividends. Tax on foreign earnings is a complex area and you should seek professional advice before buying international shares.

Thursday, April 2, 2009

Asset Allocation - Investing By The Numbers

What is asset allocation and how can it make you a better investor?

I've been reading a lot about asset allocation lately. I don't recall what prompted this sudden interest. Perhaps it's a factor of age. My investment strategy has always been heavily skewed towards Australian shares, for a number of reasons, but mainly because shares traditionally have a good return when compared to other asset classes and although they are more volatile, since retirement is still a fair way off, I was happy to accept the volatility in exchange for higher returns. However, while retirement is still a fair way off, it's still something which I need to take seriously as the recent fall in world stock markets would have been disastrous if I was about to retire.

The idea behind asset allocation is that you spread your investments across different asset classes where the risk profiles are different and the returns aren't perfectly correlated. In this way, you're taking advantage of diversification to spread your risk while at the same time you're smoothing out your returns as your investments in different asset classes grow (or sometimes decline) at varying rates at different times (to each other).

What all of this means is that (hopefully) not all of your investments will perform poorly at the same time.

What asset classes can you choose to invest in? Well this depends on how exotic you want to get. Normally, you would be choosing from equities (shares), real estate, fixed interest (bonds) and cash. However, you may break shares up according to size (ie. small cap and large cap) or by region (Australian, American, European, Asian, etc). Real estate may be broken down into residential and commercial or industrial.

Strategic Asset Allocation

Strategic asset allocation involves setting fixed percentages of your investment portfolio to be invested in each asset class. For example, a more aggressive investor might choose something like the following:

40% Shares
30% Real Estate
20% Fixed Interest
10% Cash

The above is just an example. To work out your own asset allocation, you need to consider a number of factors like your tolerance for risk, the term of your investment (are you saving for retirement or a deposit for a house?) and your stage in life (the older you get, the harder it is to recover from capital losses).

Over time, your actual portfolio will tend to move away from its original allocation. Investments will grow at different rates causing them to make up a larger or smaller percentage of your portfolio than was originally intended.

This is where portfolio re-balancing comes in. The idea is that as the value of each of your investment becomes skewed from the original allocation, you buy or sell in order to maintain the correct weighting. I like this idea as it means that you're selling down something which has outperformed and buying into something which is theoretically cheap. It also makes the decision to buy or sell more objective.

Tactical Asset Allocation

If you're not a buy and hold kind of person, then a tactical asset allocation model may hold more appeal. You still have your ideal or planned weightings for each asset class but under this model you may choose to move away from these targets for short periods of time to exploit pricing or other factors which lead you to believe that a particular asset class will outperform.

While I've read that any out-performance is purely theoretical in nature and difficult to achieve in practice, what I like about asset allocation as a methodology is that it provides a framework for investors. If properly adhered to, I think it can take some of the emotion out of investing.