The valuable diversification benefits of international exposure

16 July 2019 | Investment principles

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With protests in Hong Kong and an unresolved trade war between the United States and China, this may not seem like a wise time to invest abroad.

Looking beyond current events however, a sound investment strategy starts with an asset allocation, aligned to an individual’s goals, that is built upon reasonable expectations for risk and returns over the long-term. Well diversified investments can help investors avoid being overly exposed to unnecessary risks.

Sticking with Australian companies whose names you know may provide a comfort factor, but there’s a chance you could be leaving yourself open to some risk. As my colleague Aidan Geysen wrote recently, the portfolios of Australian investors are often highly concentrated in a small number of Australian-based companies, a risk known as home-country bias.

Underweighting international assets could cause investors to miss opportunities to temper market swings. Politics, industries and consumer sentiment vary widely by country, generating different rates of national and regional economic growth. These variations can make your portfolio less vulnerable to downturns. During the 1990s to 2000s, for example, global equities outperformed Australian equities, so investors who owned both asset classes benefitted. At other times, Australian assets have outperformed.

While investors can choose funds that focus on a single country, constructing a portfolio that is well-diversified geographically will provide additional protection against volatility related to individual economies. For example, investors could choose to add to an Australian-centric equities portfolio through a global equity fund that tracks the MSCI World (ex-Australia) Index can achieve broad geographic exposure providing investors access to about 1,600 large and medium-sized companies across 22 of 23 developed countries. Top holdings include Nestle, Johnson & Johnson and Facebook, global brands that derive revenue from around the world.

Australians are increasingly using exchange traded funds (ETFs) to increase their exposure to international assets potentially due to their accessibility and diversification at low cost.

When you travel, currency fluctuations influence how much you get for your Australian dollar. Currency fluctuations affect international investments in a similar way, so you will need to consider whether you want to invest in a fund that hedges against that risk.

It’s important to remember that while international exposure is a great way to increase balance and diversification within a portfolio, it should be done in line with investors’ long term goals, rather than as a reaction to market events or cycles.

Sticking with an asset allocation strategy aimed at achieving your financial goals in a low-cost, diversified portfolio is more likely to lead to investment success than buying and selling in response to fear or volatility.

 

Written by Robin Bowerman, Head of Corporate Affairs at Vanguard.
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Robin Bowerman, Head of Corporate Affairs at Vanguard Australia, shares investment and personal finance insights gained from over two decades in the finance industry as writer, commentator and editor.

Robin Bowerman