Picking winners overseas

As Australia’s growth profile slows, investors should keep increasing their international allocation.

Summary: As the Australian equity market is excessively weighted to the big banks and Australia’s growth profile is slowing, SMSF investors should accelerate their allocation to international stocks. The clearest growth cycle is the expansion of Asian consumerism, which will help multinational firms in industries such as fast food, pharmaceuticals, IT and communications.

Key take-out: Subject to risk tolerance or the desire for an income, an SMSF trustee should think about allocating 10 to 30 per cent of their equity investments to offshore markets.

Key beneficiaries: International investors. Category: International investing.

As one of Eureka Report’s best known contributors John Abernethy of Clime has had an exceptional record in selecting ‘value’ stocks in the Australian market. Indeed the stellar results John achieved in the past running Eureka Report ASX-based portfolios of both growth and income stocks suggest there are few people who know the local market better.

As a result, it is what you might call a watershed moment to read what John has to tell Eureka subscribers in this report he has put together for us today. 

No doubt you have heard many commentators suggest local investors must make the move to a broader and deeper diversity beyond the ASX… but coming from John it packs an extra punch. Read on.  

- managing editor James Kirby

SMSF investors should continue to lift and indeed accelerate their allocation to international stocks. This portfolio decision will diversify their Australian index exposure that has an excessive weighting to Australia’s major banks and will help them access better investment opportunities in the fast-growing Asian consumer market. Indeed Warren Buffett, in a recent interview, partly justified his equity alliance with IAG as a means of achieving this strategy for Berkshire Hathaway.

The Australian equity market has now become highly leveraged to the major banks and other financials such that, as a group, they now make up more than 35 per cent of total market capitalisation.

The other developing issue is that Australia’s growth profile is slowing as the economy transitions away from resources. The slack is not being taken up by either non-mining investment nor is there a fast tracking of public infrastructure by governments.

Low investment translates to low economic growth which in turn slows profit growth and affects broad community confidence. Indeed it is poor confidence that will continue to hit household and business demand for credit, which will restrict the major banks’ growth. The recent Federal Budget included a direct attempt to lift small business investment but I suspect that this will come and go quickly.

Another well-known issue for the banks is the requirement for higher capital requirements post the David Murray-led Financial System Inquiry. There seems little doubt that as credit demand slows and capital requirements lift the banks’ return on equity will decline. 

After 24 years of economic growth the Australian economy is meandering through a transition without a sense of urgency. This sustained period of growth suggests that Australia has been a great place to invest but it is complacent to invest by looking backwards. Throughout this long period and accelerating over the last decade has been the unrelenting growth of household debt. In this cycle the banks are big beneficiaries but household debt cannot simply continue to grow at the same rate as measured to household or national income.

In passing I note that SMSF investors can shift a portion of their local stocks from banks to more attractive industries such as health care, aged care, tourism and education. However in the main their price to valuation metrics are not attractive with excessive price-earnings multiples compared to similar stocks overseas.

Frankly there are abundant opportunities at half the multiples in offshore markets.

The clearest growth cycle is the expansion of Asian and Chinese consumerism, which will help multinational firms in industries such as fast food, pharmaceuticals, IT and communications. The emerging middle class of China should continue to expand for the next few decades and investors need to find listed companies that can access this growth.

In my view some of the biggest winners will be the big, international brands that predominantly reside on the US stock market. Some of the companies that immediately spring to mind are:

 1. Yum! Brands, which operates 41,000 restaurants in 125 countries, with brands such as KFC, Pizza Hut and Taco Bell.

2. Qualify of life and aspirational product providers, such as Proctor & Gamble and Johnson & Johnson, will also benefit.

3. Major financial institutions, such as MasterCard, American Express and Visa. They will be able to leverage the rising Asian middle class’ growing consumerism and acceptance of online purchases.

4. Major technology and digital players, including Microsoft, IBM, Facebook, Apple and Samsung will also be beneficiaries.

However, SMSF investors need to be cognisant of the risks of investing internationally, particularly currency risk. They also lose franking credits on dividends and these are valuable.

A typical balanced SMSF portfolio in accumulation stage or early pension stage and given current historic bond yields, may have 50 to 60 per cent invested in equities. Subject to risk tolerance or the desire for income a trustee should be thinking 10 to 30 per cent of the allocation to the equity class being directed to offshore equity markets.

SMSF investors can gain access to international shares either directly (Clay Carter is Eureka Report’s expert on international stocks and you can see a full list of his recommendations here) or through a fund manager. In doing so the investor needs to understand the mandate and the investment process. Indeed I believe that today SMSF investors seeking to buy international equities should do it in two steps. They should allocate cash in an offshore currency, mainly US dollars. Then they should then wait for a market correction or specific value to appear before buying.


Disclosure: The Clime International Fund is absolute return focused. Its performance for one year to May 31 was 18.53 per cent after fees. Past performance is no guarantee of future performance.