Pros of International shares
In Australia, approximately 60% (by market capitalisation) of the top 100 companies operate in a very narrow set of industries, namely financials, mining & materials, and energy. If you invest only in the Australian market, your portfolio may lack sector diversification.
By investing internationally, you get access to other sectors. For example, the top sector in the US is Information Technology, which accounts for over 20% of the 500 largest companies in the US. In Australia, information technology accounts for only 0.85% of the 100 largest companies.
If you invest only in the Australian market, the performance of your portfolio will be tied to the performance of the Australian economy. This can be problematic because your financial well being (i.e. your ability to find work, buy a house, meet interest repayments) is also tied to the performance of the Australian economy.
Investing internationally helps to diversify your investment risk, by providing access to markets outside of Australia.
Cons of international shares
Lack of familiarity
If you’re investing in Australia, there is a good chance that you have used the services of the company you are investing in, or at least be familiar with them. This is a good starting point for the due diligence an investor should complete prior to investing.
If you are investing offshore, the due diligence is a little harder as you don’t have “local knowledge”, like what’s the difference between Walmart and Home Depot? or who shops at Whole Foods? You become entirely reliant on research reports to form a view on a company, instead of first hand knowledge.
Another risk with investing internationally is foreign exchange.
When you invest internationally, you are selling Australian dollars and buying the currency of the investment. This means that the value of your investment will fall in Australian dollar terms when the Australian dollar rises, so you are exposed to the risk of the Australian dollar appreciating (going up).
If you invest via a managed fund, or an ETF, you are likely to have the option to hedge your foreign exchange rate risk. If you go with a hedged option, the fund manager will pay a fee to lock in a set foreign exchange rate. This means that you are protected if the Australian dollar appreciates, but you will miss any upside if the dollar depreciates.
Hedging does not eliminate foreign exchange rate risk, instead you are paying a fee (via the cost of the hedge) to manage it.
The decision of whether or not to hedge is a very personal one and will depend on your ability and willingness to take on risk. Foreign exchange can be very volatile, if you do not like volatility you should consider hedging any foreign exchange rate risk in your portfolio. The chart below shows the Australian Dollar / US Dollar exchange rate over the last 10 years, as you can see the rate has been very volatile.
Source: Yahoo Finance
The USD is one of the most frequently traded currencies. If you are investing offshore, try to stick to the liquid currencies (USD, Euros, Sterling) and avoid the smaller, less frequently traded currencies.
Investing internationally should result in a more diversified portfolio, if you make the right investments. If you invest in a handful of international stocks in the US technology industry, then you have added only a small additional layer of diversification to your portfolio. To get the largest diversification benefit from international stocks, try to avoid concentrating your stocks in a particular industry or country.
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