The rise of the Australian dollar doesn’t only make foreign travel and imports more attractive, foreign shares, especially ones classified as ‘global’, have become more interesting to some investors.
With our strong dollar we can afford to look at shares in the US and Japan a little more closely, or look at indirect investments offshore through managed funds or through investors, such as the about-to-list Platinum group which has made its money out investing offshore.
The head of Strategy at the AMP, Dr Shane Oliver says there is a theoretical case for Australians to have a higher allocation to global shares on a very long term view .”The recent out performance by Australian shares and the loss of their valuation advantage has made the case for global shares a bit stronger.”
But, he says that on a 3 to 5 year view Australian shares still provide better return prospects than mainstream global shares thanks mainly to the China boom and higher dividends.
Here’s his thinking.
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Australian shares have outperformed global shares dramatically so far this decade – returning 14.2% pa over the last 7 years versus 1% pa from global shares in local currency terms. Once allowance is made for the rise in the $A, global shares have lost 2% pa over the past 7 years.
After such a strong run it is natural to wonder whether investors might be wise to allocate a greater portion of their savings to global shares. Most Australian investors have a hefty bias towards Australian shares in their investment portfolios.
This is evident in typical super funds which have a benchmark exposure of 35% in Australian shares compared to 25% in global shares. However, there is a strong case for Australians to have a higher international exposure.
1. Local shares are just 2.6% of the global share market.
2. Greater exposure to global equities and foreign currency provides diversification benefits (i.e., having more assets that do not move perfectly together can help reduce the volatility of an investor’s portfolio).
3. The Australian market is under represented in key sectors such as technology and over represented in others such as financials and materials.
4. A significant international exposure provides an offset to our high foreign liabilities and our high exposure to domestic assets via residential real estate.
5. The practical barriers to offshore investing are minimal.
6. Global shares offer more scope to “add value”.
These points can be used to argue that Australians should have 60-70% of their total equity exposure in global shares.
But they are also well known. They were all the rage at the end of the 1990s after the huge relative out performance of global shares in the tech boom convinced many that global investing was the way to go.
The trouble is that such arguments are somewhat theoretical. The benefits of global diversification are hard to explain when global shares lost 2% pa over the last 7 years and Australian shares returned 14.2% pa.
They are also rather long term arguments (i.e., 10 years plus) whereas the investment horizon for most investors is only 3 years or so. It is also debatable whether the extra opportunities offered by global equity investing have ever been consistently realised by fund managers with similar or less value added relative to benchmark returns over time compared to Australian equity funds.
For these reasons we have favoured taking a medium term (3 to 5 year) view and on this basis have continued to favour Australian shares over the last few years. But is it time to move into line with theory and go more global?
The medium-term view is now more mixed, but still favours Australian shares The case to go more global now being raised by many is far more practical and short term, resting on the following.
· Australian shares are no longer good value compared to global shares because they no longer trade on a lower forward PE than global shares. The hefty out performance of Australian shares over the past few years is vulnerable to a reversal.
· The huge cash flows into Australian shares from takeovers, super, etc, risk pushing them to overvalued extremes and the proceeds some investors will receive from takeovers provide an opportunity to invest globally.
· The strong $A makes global shares “cheaper”.
However, while these considerations have certainly strengthened the case for global shares our assessment remains that Australian shares are still better placed strategically.
Firstly, the PE discount for Australian shares in the past reflected a combination of factors that are no longer relevant.
These included: a perception that Australian shares were more volatile than global shares, post 1987 concerns about the quality of Australian companies, Australia’s past high inflation status and Australia missing out on the late 1990s IT bubble.
None of these are now valid. In fact, over the past decade or so, Australian listed companies have generated better earnings growth than global shares, despite paying out a higher proportion of earnings as dividends and with lower risk.
On this basis there is no reason why Australian shares should be trading on a PE discount. In fact, maybe they should be trading on a premium.
It is worth noting that despite Australian shares lacking the breadth and diversification of global shares, over the last century they have had better real returns with similar volatility.
In other words, there is no long term evidence of under performance on a risk return basis by Australian shares.
Secondly, while Australian shares have outperformed global shares so far this decade, until recently this was really just a catch up to their chronic underperformance through the 1990s. It is only recently that the price index for Australian shares has broken out above that f
