Going Global in Australian Portfolios

We have lived in something of an investment nirvana here in Australia. We have a share market that has provided above average investment returns over long periods of time, the tax advantages of franking credits and an average dividend yield of about 4 per cent per annum, allowing people to spend their dividends and preserve their capital.

The potential cost of these good times? If the music stops and the good times end, many investors have portfolios concentrated in Australian shares and will be significantly impacted if there is an extended period of poor returns from this asset class.

How Good is Australia?

To put some numbers on the stellar Australian share market returns, the Credit Suisse Global Investment Returns Yearbook 2021 shows that from 1900 to the end of 2020, the Australian market has returned a real (after inflation) total return (price and dividends) of 6.8 per cent per annum. This compares favourably to the world average total real return of 5.3 per cent per annum over the same period. 

On top of these returns, the Australian share market has also had the benefit of franking credits in recent decades. Assuming a 4 per cent share market dividend yield and 70 per cent average franking rate across the market, franking credits add an extra 1.2 percentage points to portfolios and, for most people in retirement, will be fully refundable. 

The average share market dividend yield of 4 per cent per annum becomes 5.2 per cent when including the value of franking credits. That’s particularly attractive when managing retirement, with the possibility of keeping your capital in the share market and spending the gross dividends of 5.2 per cent.

The downside of this situation – many local investment portfolios are heavily tilted toward Australian shares. 

The Case for Global

Using simple index products, we can compare returns from global shares and Australian shares. In the 10 years to the end of December 2021, the Vanguard International Share Index fund returned 16.91 per cent per annum – quite a stellar return over a period that includes impacts from the COVID-19 downturn. This is a currency unhedged fund.

Over the same 10-year period the Vanguard Australian Shares Index Fund returned an attractive, but significantly inferior, 10.64 per cent per annum. 

The point of this comparison is not to suggest that global shares will perform better than Australian shares – it is to suggest that returns will be different, and there is likely to be a diversification benefit in including both in portfolios.

The Australian share market tends to be dominated by two industry groups, Financials (currently 28.4 per cent of the market) and Materials (19.3 per cent of the market). Global shares (MSCI World Index) provide exposure to different industry groups, including Information Technology (24.1 per cent), Financials (12.8 per cent), Healthcare (12.7 per cent), Consumer Discretionary (12.3 per cent) and Industrials (10.3 per cent).

The biggest four shares in the MSCI Wold index at the moment are Apple, Microsoft, Amazon and Tesla – worldwide businesses and brands that are not part of the Australian market. These different industries and brands are part of the diversification story for investors. Global shares provide exposure to industries and companies that can’t be accessed in Australia.

Home Country Bias

In investment terms, a home country bias refers to a tendency to overweight a person’s home investment market in a portfolio. The question is – to what extent does this happen in Australia?

According to ATO data, at June 2021 the total assets of Australian Self-Managed Super Funds (SMSF) was $822 billion. Of this amount, listed Australian shares made up the largest segment, totalling $230 billion, or 28 per cent of portfolios.

Cash and term deposits made up $151 billion or 18 per cent of portfolios. Listed and unlisted trusts and managed investments made up $199 billion, or 24 per cent of portfolios. Overseas shares and overseas managed investments made up $13.3 billion, or 1.6 per cent of portfolios while real estate assets made up $123 billion, or 15 per cent of portfolios. There were a variety of other assets, including a small value of cryptocurrencies ($200 million), collectables, some debt instruments and some ‘other’ assets.

Some proportion of the 24 per cent of SMSF investments in listed and unlisted trusts and managed investments will be overseas shares. That said, even if we make the generous assumption that half of this 24 per cent of assets are made up over overseas shares, that brings the total portfolio allocation global shares to only 13.6 per cent of portfolios.

In comparison, at the start of 2021, the Australia share market made up 2.1 per cent of the value of share markets worldwide – the biggest market was the USA (55.9 per cent) followed by Japan (7.4 per cent) and China (5.1 per cent). Provided our 2.1 per cent continues to perform well, investors will be fine. However, many investors are putting a lot of faith in a comparatively small slice of world markets.

Asset Allocations of Fund Managers

Professional investment managers seem to be a little more confident in including global shares in investment portfolios. For example, the 30 September investment update for the Future Fund had 8.1 per cent of the fund invested in Australian shares, 16.6 per cent in developed market global shares and 8.3 per cent of the fund invested in emerging market global shares. The biggest investment holdings of the fund were cash (15.0 per cent) and private equity (17.3 per cent).

As another example, the Q Super (QLD Government Superannuation Fund) Balanced Fund current has 40.5 per cent of the fund invested in equities. This includes 7.1 per cent of the fund in Australian shares, 26.4 per cent in global shares and 6.9 per cent in private equity.

Conclusion

Asset allocation in a key decision that drives portfolio returns, and the decision as to the balance of Australian and global shares amongst the growth assets of a portfolio is crucial. Given the tendency to favour home countries in portfolios, given the stellar returns from Australian shares over time (but not guaranteed in the future), given the benefits and simplicity of strong dividend yields and franking credits from the Australian market, it is no wonder that many Australian portfolios have a lot of exposure to Australian shares. 

The question is – would a little more exposure to global shares provide a portfolio that is better suited to cope with the unknowns of the future?