Many people are far too exposed to the local economy, writes John Carran, senior economist at Gareth Morgan Investments.
Recently some financial industry participants have predicted that New Zealand fund managers will invest more of their portfolios overseas as the growth in KiwiSaver funds outpaces the capacity of the local sharemarket to absorb them. I agree with this prognosis. Flooding the local market with funds beyond its capacity to absorb them is a recipe for poor quality investments and low returns.
Aside from this argument I consider that there are three other reasons why for many investors it makes sense to have a good portion of holdings overseas.
Reason 1: Reduce exposure to the New Zealand economy
People are heavily exposed to the economy through their jobs and their houses. If it tanks many peoples' earnings and property values go down the drain.
In times of economic hardship the local sharemarket is no haven for local investors. Over time it is dependent on the performance of the domestic economy, particularly domestic consumption, as the accompanying graph shows. So in fact in a downturn investors with their savings exposed to the domestic sharemarket get a triple whammy - through their jobs, houses, and share investments.
Overseas investments are free of the vagaries of the local economy. Holding a decent proportion of diversified overseas investments means that wealth won't be as badly affected if the economy slumps.
Admittedly the global financial crisis crushed international markets at least as much as local markets.
But, over longer periods, the link between New Zealand and overseas markets would be weaker, making overseas investments a hedge against exposure to the domestic economy.
Reason 2: Wider choice of companies, securities and sectors
According to World Bank statistics the New Zealand sharemarket is around 0.2 per cent of total global sharemarket capitalisation and roughly compares in size to countries such as Peru, Portugal and Luxembourg.
It is heavily concentrated in areas such as telecommunications, construction and transport and there is little exposure to the agriculture sector because of its tightly controlled ownership structure.
People can invest, either directly or through managed funds, in a universe of overseas securities across the spectrum of markets, sectors and industries.
For example, New Zealand investors can participate as well as anyone in tech successes such as Apple, Samsung and Google, or global corporate behemoths such as Nike, McDonald's and Coca-Cola.
Overseas markets provide much greater opportunities for diversification across a wide variety of local and global economic conditions.
Reason 3: Greater exposure to fast growing emerging markets
Emerging economies such as China, India, Russia, Brazil, and Indonesia are growing rapidly as they take advantage of new technologies and favourable demographics to become more productive.
In contrast, growth in developed countries such as many in Europe, the United States, and New Zealand, will be relatively tepid as their populations age. Investments exposed to emerging markets, therefore, offer opportunities for higher average returns.
However higher returns from emerging market investments will often bring higher risks, which will deter many New Zealand investors. But as a small part of a well-diversified global portfolio, emerging market investments have the potential to add extra kick to returns over time without significant additional risk.
In the future it is possible that many emerging country financial exchanges will become better regulated and more transparent, reducing the risks involved in investing in these markets and allowing greater opportunities for investors from developed countries.
Investing overseas won't be for everyone. Some investors will prefer investing in local companies and securities they know and trust. There will be local success stories and some investors will be confident they can pick the winners. Fluctuations in the New Zealand dollar can lead to volatile domestic currency returns on overseas investments, which can be off-putting. It can also be expensive to directly invest in overseas securities because of brokerage and custody fees. However, these issues can be mitigated by investing through diversified investment funds incorporating New Zealand dollar hedging.
In general, it is inevitable that a greater proportion of New Zealand savings will be invested overseas. This should be welcomed as over time it will provide more diversification and the opportunity for better returns on savings.
Ultimately this should allow better incomes and higher standards of living in retirement.
Any opinions in this article are the author's own. They are of a general nature and should not be treated as a recommendation or guidance to any individual. Everyone's financial circumstances are different, and readers should seek specific financial advice appropriate for their circumstances before making an investment decision.