Ways to invest in international shares
There are a number of ways to invest in a portfolio of international shares. Some of these include mFunds which are unlisted managed funds, and listed investment companies that you can buy on the Australian Securities Exchange (ASX).
Growing in popularity however, is exchange traded funds (ETFs), which offer a simple and easy way to invest in a portfolio of international shares.
ETFs can allow you to access tens, hundreds or thousands of stocks in one ASX trade. The U.S. has long been one of the most popular international markets with Australian investors and has only grown in popularity as the barriers to entry and fees have reduced.
ETFs also offer a great deal of choice. There are broad market international ETFs that allow you to own all of the world’s largest companies; many that focus on a certain region, such as Asia or Europe; and ETFs that allow you to invest in an individual sector – think technology, healthcare or infrastructure.
In recent years Australians have been embracing ETFs as a way to gain access to global investment opportunities. As at August 2020, there was almost $29 billion invested in ETFs tracking global shares on the ASX.
The simplest way to build an international equity portfolio is to buy everything, which can be done by buying a combination of ETFs that cover the vast majority of global stock markets.
Two common ways we see investors construct international equity portfolio are:
1. With a regional focus
There are three main international regions (1) North America – dominated by the U.S. (2) Asia. (3) Europe.
A simple way to approach allocation to each region is to weight the exposure to the relative size of the region (see example of a $10,000 portfolio below).
Source: Percentage weights World Federation of Exchanges, LSE and Bell Direct calculations
Investors then have the flexibility to dial up or dial down each exposure to express a point of view. For example, you may believe growth in the U.S. will outpace growth in Europe – if that is the case, then you can sell some of the European ETF and buy more of the U.S. ETF.
2. With a developed and emerging market focus
An alternative way to approach investing internationally is by separating developed and emerging markets. Developed market economies, such as the US and Australia, make up about 87% of global stock markets. Emerging markets, such as China and Brazil, make up about 13%.
The below portfolio example reflects these weightings.
Source: MSCI, October 2020
Managing currency risk
There are however, some risks to be aware of when investing internationally. The major risk to be aware of is fluctuations in foreign exchange rates impacting your portfolio returns.
Let’s say, for example, you own U.S. equities and the U.S. dollar (USD) weakens against the Australian dollar (AUD) by 5%. The result would be that your U.S. equities are worth 5% less when they are converted into Australian dollars.
Of course, currency risk can also work in your favour. If the greenback strengthens against the Australian dollar by 5%, this would deliver gains for your portfolio as it would be worth 5% more on selling it.
The role of hedging
Hedging takes out the impact of currency. Hedged ETFs enter into forward exchange contracts with another party to essentially lock in a set exchange rate for the future, to reduce the impact of currency fluctuations.
However, a downside of this approach is that hedging can remove some of the diversification benefits of investing in the assets of another currency and may increase your dependence on the Australian economy. Hedging can also be difficult when investing in ETFs that track multiple markets.
The table below provides an overview of the impact of currency movements on your portfolio, from both a hedged and unhedged perspective.
Ultimately the table shows the best returns occur when US markets go up and the AUD goes down relative to the USD.
In the second international equity portfolio explained above, VGAD and VGS were given as the options to gain exposure to developed markets. They each invest in the same companies, however VGAD’s currency exposure is hedged and VGS’s currency exposure is unhedged.
The choice between the products comes down to your view on currency. For example, if you believed the AUD was going to go up against other international currencies you would invest in VGAD. Alternatively, if you felt the AUD was going to go down against other international currencies then you would invest in VGS.
The fact of the matter is that picking currency movements is very difficult.
As a rule of thumb, if you have a long-term investment horizon (five years or more), are seeking the full diversification benefits and are prepared to cope with some of the ups and downs that can result from currency fluctuations, investing in a straightforward unhedged ETF makes sense. Hedging costs extra (higher fees), so if you have time up your sleeve to ride out any volatility, it’s best for that money to stay in your investment portfolio.
However, if you have a shorter-term investment horizon or a lower tolerance for volatility, hedging a portion of your international investment can be a useful way to reduce the currency risk and provide smoother returns for your portfolio.
Summary
By spreading investment risk across a broader range of geographies and regions, a global focus can help diversify your portfolio and potentially improve your investment return.
Investing globally also gives you access to some of the world’s major economies and markets, so you can tap into some of the major themes that are driving global growth.
Top three take outs
The Australian market makes up a mere 2% of the total global market – so investing offshore offers compelling opportunities for Australian investors
Selecting individual international companies to invest in can be difficult and risky, so ETFs can be a simple and easy way to gain exposure to the largest global organisations.
International currency movements need to be factored in, but can also offer an additional layer of diversification to your portfolio
Important Disclaimer- This information is for educational purposes only and is of a general nature. It has been prepared without consideration of your specific financial situation, particular needs and investment objectives. This information does not constitute financial advice and you should consider your own financial circumstances in assessing the appropriateness of this information.
