Diana Clement: Investing overseas can be a tricky business

Overseas investing opens up greater opportunities to build your nest egg. Photo / Thinkstock

New Zealand offers mighty limited choices when it comes to diversification.

Our so-called blue-chip companies such as Fletcher Building (market capitalisation of $5.6 billion) are minnows compared to the overseas big boys such as IBM with a market capitalisation of US$211.7 billion ($250.4 billion) or Pfizer at US$158.8 billion.

Growth on the NZX simply doesn't keep pace with that of emerging markets in Asia, whose economies are growing at a much greater pace.

What's more, there are asset classes such as commodities, alternative energy, infrastructure and proper blue-chips, which you simply can't get access to in any meaningful way without going offshore, says Janine Starks, co-managing director at Liontamer Investments.

The $64,000 question is how to invest overseas. Investors could simply buy units in a New Zealand-based international managed fund. A list of most of those available can be found on Fundsource.co.nz.

A financial adviser can arrange suitable investments through a fund manager. It's "free" in a sense because the adviser takes a commission from the fund manager. The downside of that is that the adviser may be limited in the investments he or she can recommend.

A fee-based adviser or stock- broker might recommend either New Zealand-based managed funds that invest overseas or investments in overseas stockmarket-traded investments.

Broker Dan Stratful of IRG Equity Investment Advisers says some sophisticated private investors go direct to an overseas broker because the commissions are lower.

Many prefer to deal with a New Zealand broker. Typically, says Stratful, his company places the overseas portion of those clients' investments in stockmarket-listed funds (called listed trusts and exchange-traded funds) on UK and US stock exchanges.

For DIY investors, finding an overseas broker to trade through can be a difficult task thanks to money laundering and other laws, which all but prevent brokers in the US and UK taking on overseas-based customers such as those in New Zealand. Share trading forums such as Sharetrader.co.nz have postings from frustrated investors who can't find a broker.

There are online brokers that may be willing to take on New Zealand-based clients. They can be tracked down with Google searches - try "expatriate broker" - although investors need to do their homework on the broker before sending off large sums of money to invest to ensure it is legitimate.

Direct investment overseas exposes small investors to both opportunities and risks. On one hand, they pay lower fees and have greater options for diversification.

On the other hand currency is a major bugbear for Kiwi investors, says Starks. "The New Zealand dollar is up and down like a yo-yo and it makes offshore investing an unpleasant experience for New Zealanders."

If you're going to invest overseas in funds you need to know a little about "hedging", which is a bit of jiggery pokery that fund managers use to ensure that returns don't vary even if the kiwi is bobbing up and down. Very simply, the fund manager is investing in the background in derivatives to offset the currency movements.

"A New Zealand investor buying an offshore fund with no full or partial hedge in place is basically buying a currency fund and ramping up the risk to a level which I believe they don't understand," says Starks.

"This masks the real intent of their investment, which was to get access to various offshore asset classes such as equities or commodities.

"I believe the noise and distortion created by our currency is too great for retail investors to tolerate, and causes them to make bad investment decisions when things go wrong."

Starks says fund managers are equity experts, not currency experts.

"I started my career on an FX dealing floor as a currency dealer, which probably influences my views quite a lot. When you've been on the inside, it raises your level of caution when fund managers believe they can get the calls right.

"New Zealand is full of small teams, so I'm a bit cynical of the resources. I don't think being an equity expert automatically makes you a currency expert, and the currency markets are full of surprises which no one predicts, even the best analysts."

Investors can choose to buy unhedged funds or a mixture of hedged and unhedged funds. It's often said that a 50/50 balance is best. But that decision is up to investors and their financial advisers to decide.

Fund manager AMP Capital Investors provides clients with the ability to manage their own currency hedging of their global share exposure. "We recognise that each investor has a unique risk profile - and each has a different perception as to what their currency exposure should be," says Grant Hassell, head of fixed income for AMP Capital Investors.

"We provide a product that enables investors to choose the extent to which they hedge their global shares back to the New Zealand dollar by selecting the mix of hedged and unhedged shares that suits them; for example, 30 per cent hedged and 70 per cent unhedged might suit one group of investors."

The majority of customers are large superannuation funds, which will have their own hedging policy, but they are able to use the same products as individual investors. AMP Capital Investors' funds are available to the public through platforms such as RaboDirect.

It costs marginally more to run managed funds this way, which is reflected in the fees, but can be comforting for investors who can't face too much volatility in their returns.

If you've survived the yo-yo-ing of the New Zealand dollar, there is one other gotcha for Kiwi investors looking to put a chunk of money overseas. That's the foreign investment fund (FIF) tax rules, which are a type of capital gains tax.

In general the rules kick in for investors who have paid more than $50,000 for overseas investments. Those investments might have been bought directly in a foreign country, through a New Zealand broker, or on the NZX in foreign-based investments such as Foreign & Colonial and Templeton funds.

The capital gains on those foreign investments need to be included in an investor's IR3 and tax paid on them.

It means that investors are paying tax on the unrealised capital gains and inflation on their investments each year, which can be quite painful if you don't have cash coming in to fund payments to the IRD.

"[The FIF rules] can be a good or a bad thing," says Steve Camage, tax director at PwC. Share traders are actually better off than they were in the past because they are limited to paying tax on 5 per cent of the capital gain each year.

On the other hand buy and hold investors are paying more tax than they would have in the past. What's more, if they make a loss one year, they will pay tax the following year on "growth" that simply returns them back to square one.

"Investors need to get some [tax] advice before they go in [to foreign investments]," says Camage. "They think that normal tax rules apply and that they can buy [overseas] shares and not worry about it."

The reality is that the FIF rules make it very difficult for people to do their own taxes and may require an accountant. The investors may be pushed into paying provisional tax and filing an annual IR3 as a result of owning their foreign investments.

Camage stresses that he is not a financial adviser, but notes that people forget that offshore investments often bring a greater capital return than New Zealand-based ones. "Getting 67 per cent [return] on a larger capital gain can be better than 100 per cent of smaller gains in New Zealand."

Investors who don't want the hassle may prefer to invest in Portfolio Investment Entity (Pie) funds that specialise in overseas investments. Those funds still pay tax on the unrealised gains each year, but the hard accounting work is done for the investor.

Having said that, says Starks, Pie investors pay tax even when their investment makes a loss "and that's hard to digest. FIF investors pay no tax if there are no gains."

She adds that the old tax rules apply to investors with roughly less than $50,000 invested overseas allowing investors in funds other than Pie funds to receive their gains tax-free.