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If you have not already done so you should consider whether your portfolio is sufficiently diversified, particularly regarding its exposure to the relatively small Australian economy.

share-diversificationDiversification in your asset allocation is the primary driver of investment return.  Research has shown that about 95% of return is due to the selection of the mix of asset classes that are best suited to meeting your investment objectives and the balance of the return is from selection of fund managers or individual investments within each asset class.  

Over the long term the value of a share can be expected to grow in line with the economy/economies in which it operates.  Australian growth is currently in the doldrums.  International equity and debt investments provide greater opportunity for potential growth and greater diversification of industry.

Historically Australian investors have held a strong preference for investing in our own market.  A home bias is a natural position for any investor.  There are many reasons why, in the past, this strategy has been successful:

  • Australia has enjoyed a prolonged period of continuous economic growth.  This has been the primary driver of value for shares in our market.
  • Australian companies on average pay higher dividends than their international counterparts.
  • We have strong trading ties with the fastest growing world economies.
  • We had a strong relative economic advantage with our large pool of natural resources.  This is an advantage when the resource is scarce and the demand is high.  Technology has made our resources less valuable. 

Previously expensive reserves can now be extracted much more cheaply, flooding the market.  The slowing and refocussing of the Chinese economy has also not helped. 

Unfortunately our economic success has led to issues that mean the economy will struggle for some time.  These issues include

  • A currency that stayed persistently high, causing our manufacturing sector to become uncompetitive, particularly compared to our Asian neighbours.  
  • The recent Free Trade Agreements will not allow our manufacturing sector to recover despite a fall in the currency.
  • High wages and salaries.  This means industry needs to be able to generate large sales per employee to enable current income levels to continue.  This can be achieved either from service industries or those where large capital is controlled by a small group of highly skilled workers e.g. medical research.  While this gets into gear the unemployment rate will rise.
  • Australians have high levels of personal debt.  Our houses are among the largest and most expensive in the world.  This directs a large part of the family budget to paying for the house and less to current spending.  This has allowed the banks to become very large at the expense of other industries.
  • Business and consumer confidence are at low levels.  
  • Due to lack of belief in the future, non-mining business investment is at its lowest level since the recession of 1951.  Yes 1951! Investment is required to promote growth.

Longer term, after we get past these difficulties, Australia is a good position.  Shorter term, however, there are better opportunities to be explored outside Australia. 

The United States is aggressively prodding its economy to grow and will continue to err on the side of growth.  Europe is changing its process from austerity (raising taxes and cutting expenditure) to pump priming the economy (the opposite) to try and help the economy achieve its full potential.  Australia sits in the middle, doing a little of both, and the economy continues to struggle.

There is an expectation that as the US raises interest rates there will be a flow of money into the US.  This will have multiple impacts.  Their currency will appreciate and financial markets will continue to have new money being invested and supporting prices.  An unhedged investment in the US share market would participate in both the expected rise in the market and the growth in the value of the US dollar.

The US share market has a more even spread between across its 10 sectors and much greater opportunities in Health Care, Consumer Discretionary and Information Technology.  This is illustrated in the chart below.  In Australia 8 of the 10 sectors have less than the average 10% of the market.  In the US half the sectors have more than 10% of the overall market and half have less.  The US market is much more diversified than the Australian market. 

sector-diversification-international-shares

There are many compelling reasons to widen your investment horizons beyond our local share market.  It is possible to invest in either a hedged manner where currency risk is removed or unhedged where currency risk remains.  When our currency falls relative to international currencies an unhedged investment benefits from that fall.  Quite often when markets misbehave there is a rush to the safety of the US currency.  This pushes the value of our currency down, offsetting the impact of the fall in overseas markets.  This provides some automatic downside protection.

Segue Financial Services

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307-313 Wattletree Road

Malvern East VIC 3145

Phone: 9509 1599

Fax:+61 (03) 9509 1577

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