Why International Equities?

A core belief of our investment philosophy is that to identify the best investment prospects, a global investment universe offering the deepest pool of opportunities has to be interrogated. The following serves to illustrate this from the perspective of an Australian based investor.

In comparison to a local investor constrained to ASX listed equities, the MSCI World Index offers an investment universe over thirty times the size by value when compared to the S&P ASX 300 Index.

Moreover, when interrogating the composition of these indices, the relative lack of opportunity and the embedded risk to an investor with an ASX-only portfolio being managed to an index as concentrated as the S&P ASX 300, is quite alarming.

Index Breakdown – Five Largest Sectors by Index Weight

Over half of the Australian market as defined by the S&P ASX 300 Index is represented by two sectors, Financials and Materials. By definition, active and passive funds investing relative to this index are exposing investors to higher absolute risk through a lack of portfolio diversification when compared to the MSCI World Index. Furthermore, investors with ASX-only portfolios are significantly under-exposed to sectors like Information Technology which will be critically important in shaping the future. The S&P ASX 300 Index has a weighting of only 1.5% to Information Technology!

Australian based investors investing in international equities also benefit by virtue of diversifying investment exposure away from the Australian dollar (AUD). The AUD has historically behaved as a risk currency and in bear markets a weaker AUD can act as a natural hedge, bolstering the AUD value of international equities. The chart below shows the relative returns of the S&P ASX 300 Index (AUD) and MSCI World Index in both USD and AUD from the start of 2008, capturing the market fall associated with the Global Financial Crisis (GFC), and subsequent recovery.

What is clearly evident is that the MSCI World Index denominated in AUD sheltered investors better through the depths of the GFC, which bottomed in March 2009. The AUD falling in line with global equity markets acted as a foil to the drawdown of the MSCI World Index in USD, the base currency of that index.

While the relationship of the AUD to the MSCI World Index has acted to preserve capital in falling markets, international investors in AUD terms have also experienced a bonus in recovering markets post GFC with the USD and other currencies better reflecting improving economic conditions (versus Australia) in response to stimulus measures.

The old adage states that there is no return without risk. As investors we seek the highest return (capital and income) for an acceptable level of risk assumed. The relationship of the AUD versus the MSCI World Index (USD) has historically acted to dampen the volatility and consequently the risk for Australians investing internationally on an index that is substantially larger and broader based than the S&P ASX 300 Index.

This is evidenced in the table below that looks at the total return for risk taken of the MSCI World Index in US and Australian dollars and for the smaller, highly concentrated S&P ASX 300 Index. The return for risk profile over the last ten years has favoured the MSCI World Index in AUD, with the S&P ASX 300 Index the least attractive.

The MSCI World Index is the starting point for our global investment capability. Our investment approach employed by our team has proven able to identify the best investment opportunities available from a larger, broader and more prospective investment universe to deliver our clients superior returns above those of the MSCI World Index denominated in AUD.

Investors with ASX-heavy portfolios should consider the benefits of an increased allocation to international equities. That is, the vastly expanded universe of potential underlying investments, access to companies and industries that simply isn’t available via the ASX, diversifying risk by broadening the source of portfolio returns, and lastly the potential natural partial hedge when international exposures are managed in AUD which helps preserve capital in periods of market weakness. This makes it most notable, that according to the Australian Tax Office, less than one percent of Australia’s Self-Managed Super Fund market is allocated to direct investments in international equities!

Please note that past performance is not indicative or a guarantee of future performance. This is the case for past returns and past volatility, for both equity markets and currency markets. Investing internationally involves exposure to currency risk, which can increase or decrease performance returns.