Why invest in international shares?

Looking at recent history and from a returns perspective only, there would appear to be little point in investing in international shares. However, this is akin to driving by looking only in the rear view mirror. Broader longer term issues need to be considered when constructing a portfolio: notably risk and diversification. Over the longer term the currency effect between unhedged and hedged international shares should wash out, but there are moments of extremes which potentially provide attractive entry points. Glen Stevens, Governor of the Reserve Bank of Australia said on 6 November 2012 that “The exchange rate, though, remains higher than might have been expected, given the observed decline in export prices and the weaker global outlook”. Furthermore, the Australian Dollar is a volatile currency. It usually falls at times of economic crisis, and therefore provides a cushion to equity market falls for investors with unhedged overseas assets.

There may be good reasons for the relative performance differential between Australian and International shares over the last decade but in the 10 and 20 year periods to 31 December 1999 International shares returns far exceeded Australian share returns. International shares are no longer expensive on a relative basis. Given the significantly lower volatility and correlation to Australian equities that unhedged international shares possess, there are more diversification benefits to investing in this asset class as compared to hedged international shares.

Australian investors can also diversify away from some significant sector bias in their home market at the same time as accessing important global sectors such as Information Technology and Healthcare where there is little representation domestically. The international opportunity set is vast and broadly diversified across sectors with different sensitivities to the economic cycle. There are also a number of high quality managers which can be combined to create robust and well diversified investment portfolios and, which have the potential to add value over time.

In summary, investing in international shares helps improve the overall risk adjusted returns profile of a portfolio whilst increasing the opportunity set and providing diversification away from a highly concentrated local market. When you couple this with an Australian Dollar at elevated levels, and relative equity valuations in more neutral territory, I believe investors should benefit from a tilt to international shares over Australian shares in the long run.