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Why global equities are relevant for Australian investors

Why global equities are relevant for SMSFs

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You open the papers daily to hear about the rise of a new superpower and the collapse of old empires. Your friends talk about the opening of new markets globally and of free trade and travel. Your country is perfectly positioned to provide the food to fuel this growing demand with ample room to expand for cattle and crops. Your fellow citizens are amongst the richest in the world: five times richer than the nearest large neighbour (regarded as more of a holiday destination than a serious competitor) and 50% higher than the country from which many of your citizens originated. In short – your country is on the cusp of great things.

You could read the above and think of Australia. Indeed you’d be forgiven for thinking that: expecting the neighbour to be Indonesia and the UK to be the country of origin.

In fact the story above refers to Argentina in 1909, with Brazil and Italy being the neighbour and source country respectively.

Argentina is a sad story and a tale of blown opportunities. A country endowed with both natural resources and new population that has been stuck in the slow lane for 100 years, racked with recurrent inflation and instability.

So why is this relevant to you as a SMSF trustee? Because when it comes to protecting your wealth over the long term, there are many things that can go wrong in a manner in which you had not anticipated, such as a collapse in your home country’s terms of trade coupled with a succession of poor governments. The hidden dangers in an Argentine pension portfolio in 1909 might have come from too narrow a dependency on local assets compounded by currency risk. And this assumes the assets were equities rather than regularly defaulted on bonds or bank deposits!

We here at Morphic, in response to some questions from a number of SMSFs, have put together a short article on why we think it is incredibly importantly for SMSFs to look offshore for their investments to protect their future retirement plans.

Global equities are outperforming Australian equities

“A first-rate organizer is never in a hurry. He is never late. He always keeps up his sleeve a margin for the unexpected.”
Arnold Bennett

At Morphic Asset Management, we believe we detect the beginning of a multi-decade trend of Global equities outperforming Australian stock market. 

There are good macroeconomic reasons for that. Chinese booming demand for resources in the Noughties has normalised and spending on investment (in infrastructure, property and machinery) is set to decline in the next decade. This is not to say the “China story” is over, just that there will be different drivers of growth. Indeed, the Morphic Global Opportunities Fund holds investments in Chinese companies set to benefit from progressive modernisation and the growing middle class. 

Global equities are a good diversifier for Australian stocks

“In investing, what is comfortable is rarely profitable.”
Robert Arnott

Part of successful portfolio construction is to diversify your risks. Most investors see this in terms of having some equities along with cash, bonds and property. Yet it would seem that the SMSF community hasn’t taken the next step of looking at currency risks.

By adding some international funds to your SMSF, you can also gain exposure to sectors which are under-represented in Australia. The Australian stock market essentially represents an exposure to banks and resource companies, with this combination representing almost 2/3 of the index.

Global equities provide greater diversification across all other sectors, with important investing opportunities in information technology, healthcare, industrials and consumer discretionary and to other currencies. 

Global equities are also good for “de-risking” a typical portfolio of Australian stocks. One way to look at it is examine the returns of Global equities when Australian shares lose in value. Since inception, Morphic Global Opportunities Fund, for example, has outperformed the All Ordinaries Index in nine out of 10 worst months for the Australian stock market. 

Perhaps the most startling thing about SMSFs’ currency allocation strategies is that they don’t seem to have one! ATO figures put average international equity holdings at just 0.3% of SMSF asset allocations. To say that the SMSF sector is taking a large bet on Australia and the continuation of the current trends in China, would be an understatement. 

A recent international survey of retirement plans suggests that SMSFs need to increase the investment in Global Equities to about 14% of their portfolio just to match the average of international savers.

International Assets are a good match for future expenses

“Paris is always a good idea”
Audrey Hepburn

We’re not sure about you, but one of our aims in retirement is to spend time travelling to parts of the world that we had always wanted to visit, but never had the time – what with four weeks annual leave and then the trips with the kids that came after that.

Australia over the last 10 years has enjoyed one of the highest exchange rates in real terms, since either 1950 or 1890 depending on how it is measured. As such most people have become accustomed to travelling with their Australian Dollars buying a good holiday. We would just point out, that this period has been the exception, rather than the norm over the last 50 years.

We believe it is entirely possible that the next 10 to 20 years could see the Australian dollar fall by 30- 40% against the standard basket of Australia’s trading partners, which is represented by the so called “Trade Weighted Index” or TWI charted below. Investors who only have Australian assets, will need these to appreciate by at least this amount to just match the currency fall. Unfortunately, historically times when the Australian dollar is weak have also often been times when the Australian stock market gives lacklustre returns.

By looking offshore, if SMSF investors one day find the outlook at home less rosy, they will be safe in the knowledge that their global purchasing power for those overseas trips they always planned in their retirement hasn’t ended in tears!

Lastly, an SMSF should also consider the costs of what they spend money on each year on things that are actually imported and would go up in prices in coming years, reducing the ability of the savings to buy what they wanted. The most obvious example are imported cars, particularly from Europe, which could rise a lot in price. 

How to go about investing overseas

“When preparing to travel, lay out all your clothes and all your money. Then take half the clothes and twice the money.”
Susan Heller

If SMSFs are going to overcome their home bias and look to change their asset allocation strategy, a few issues that confront them from the beginning are: currency risk; low yields on large overseas stocks; and whether to invest direct in a few stocks or choose a managed fund or the ETF route.

Very few of even the big allocators (e.g. Future Fund) seek to buy individual stocks since their overall risk management practices involve outsourcing the investment process to fund managers.

Many SMSFs take a direct investing stance when it comes to Australian equities and probably feel qualified to pick on a few big international stocks, like Microsoft, Coke and Apple, and feel this might meet risk and return challenges.

But this would ignore a number of investing rules. This is more oriented towards investing based solely on a company’s past reputation without necessarily delving very deeply into its future prospects. Nor does it take into account some of the macroeconomic risks, like which are the best economies and sectors to be investing in at any given time, microeconomic risks like comparative stock performances and differing individual currency trends.

If SMSFs do recognise the risks of stock picking themselves they will need to take the managed fund route.

The remaining question is whether to buy a collection of so-called “passive” funds like Exchange Traded Funds or Index Funds. We believe that for all the hype about the advantages of passive funds, this is more a reflection of the very strong upward trend that the global stock market has seen since 2009, and that in periods when markets are more choppy and you get bigger variances between the performances of individual stock markets and industrial sectors, many active funds (like the one we run) will do better because of their greater flexibility, including the capacity to be less invested; manage currency risks; and also switch between different countries and sectors.

We might have a day job that involves investing but when we combine what we know from that arena with our responsibilities as trustees for our own family super funds, we recognise the need follow the large Endowment funds of the US and Europe examples and bow to the skills and focus of fund managers.

Perhaps when it comes to allocating to global equities, you might understand our personal bias in choosing one particular global manager but our purpose here is really to point out what seems an anomaly in the divergence of asset allocation strategies between a prudent and diversified equities portfolio and the current investment practice of many SMSFs.

 

Authors

Jack Lowenstein and Chad Slater