Australian investors are going global. Big time. They are no longer questioning whether they should invest overseas, but what to buy and how much. For the first time international shares topped Assirt's inflow of funds figures for specialist sectors including local shares when investors poured $3.4 billion into funds investing offshore - boosting the total to $13.5 billion for overseas equities - over the year to the end of June. This flow of funds alone is more than the total $3 billion in foreign shares in 1993. Overseas shares have been the star performer among all asset classes. It returned 30.5 per cent based on the common index for the performance of overseas shares, the Morgan Stanley Capital International Index (MSCI). In contrast the Australian market's S&P/ASX 200 index rose 18.5 per cent in the 12 months to September 30, 2000.

But when you are looking at these mesmerising returns, remember that much of the difference is explained by the effect of the weak Australian dollar.

Navigating a minefield -Top of Article

For investors who believe overseas shares are too risky, particularly with an unstable Australian dollar, here is what you need to know.

 The main reason for foreign investing is diversification. Australia has a tiny 1.2 per cent of the world's market capitalisation, according to the MSCI world index. The index aggregates share returns for major stocks across all the markets of the world. The other components of the index are the US (49 per cent), Japan (14 per cent), other Asian countries (2 per cent), Britain (9 per cent), Germany (5 per cent), other European countries (18 per cent) and Canada (2 per cent).

 By investing solely in the Australian market, you may miss the growth opportunities of the 21st century, and some important sectors not well represented locally. Industries such as car manufacturing, airlines, information technology, telecommunications, health and personal care are not as big here as they are overseas.

 'There are whole industries - those of the 21st century - that are absent here and you can't get into them unless you go overseas,' says Alan Schoenheimer, managing director-Australasia, of Frank Russell Company.

 The flip side is that investing in Australian companies provides unique opportunities such as resources, the wine industry and biotechnology.

 But investing offshore provides diversification across some of the world's most powerful economies.

Hedging International Bets -Top of Article

'Economic conditions vary from country to country and from year to year. Diversifying a portfolio across countries can allow you to take advantage of better performing economies and minimise the effect of poorer performers,' says Natalie Comino, investment research manager at MLC.

 She says research shows that no one country continually outperformed the others year after year. There has also been no clear pattern of a particular country outperforming the others in any given year.

 'The solution is diversification across countries,' Comino explains.

 Understanding sharemarkets is the easy part of investing overseas. The hard part is learning how the currency works. The direction of the $A will influence how much money your investments will gain or lose. Schoenheimer says that half of the strong performance of overseas shares last year was due to the falling currency. When the dollar goes down, foreign securities rise in value. Travellers will be aware of this effect because overseas purchases become more expensive.

 For example, the share price of a $100 share in an American company remains unchanged. Then the $A falls 10 per cent against the $US, and the price of the share rises to $A110. You have made money on the direction of the currency, not the share price.

 If you still need convincing, then look at history's lessons about international shares. Compared to Australian shares they are less volatile. According to analysis of returns by asset consultancy the Frank Russell Company, the volatility of returns for Australian shares between 1970 and 1999 is 25.5 per cent. International shares were 20 per cent less volatile with a risk measure of 20.3 per cent.

 Australian shares had some bad years - 11 in 30 have been negative, compared with international's score of six in 30, according to Frank Russell. And the extent of the negative return is worse in Australia with six years in 30 below 10 per cent, compared with three in 30 years below 10 per cent.

 The main reason for lower volatility is that international shares as an asset class are diverse. This diversity reduces the volatility.

 Schoenheimer has placed 70 per cent of his own superannuation in overseas markets.

 He has no fixed interest and all growth assets. 'I personally believe that Australians have too little exposure overseas,' he says. He says this could be because Australian investors have a patriotic fervor for local shares, but he appeals to investors to look into the brands like Nestlé, Pfizer, Nokia, Nortel and Motorola.

But is it the right time to invest overseas? - Top of Article

 There is concern about the future direction of the US market. It has had a strong, nine-year economic cycle. Where will it go from here? There is much speculation among economists about whether the $A will fall any further. If it rises it will hurt overseas investments.

 'Don't be put off, it is better to be in the market than out. It is time-in rather than timing,' Comino advises. 'I've seen so many clients and advisers who thought the overseas market was overheated a few years ago and they sat on their money to wait until it came down and they missed out on all the gains,' she says.

 Paul Durham, head of research equities, at BT Funds Management, believes the US equity market is not fundamentally overvalued. It is not in a bubble and the recent pullback in the US equity market has put the market on track again. He says that there are exciting opportunities in the US that an active manager such as BT can take advantage of.

 There are other views too. For example, Credit Suisse's international shares update says that a pickup in other regions should largely offset expected US relative underperformance. It also believes the $A will rise to 60 cents against the $US over the next year.

 How much overseas? If you have your superannuation in a balanced fund with growth assets you already have overseas investments. The average for this type of superannuation fund is about 21 per cent invested overseas in shares or bonds.

 Self-managed superannuation funds, formerly known as DIY funds, are drastically 'underweight' in overseas investments. According to research group Rainmaker, SMSFs had an average of 27 per cent invested in both local and overseas shares compared with a balanced fund's asset allocation of 65 per cent in shares.

 Thomas Murphy, head of investment research at Deutsche Bank, says that if you have a horizon of more than 20 years you can afford the highest amount of 40 to 50 per cent in foreign markets. This is particularly so if you are a young investor with most of your working life ahead of you.

If your horizon is shorter, typically five to 10 years, he recommends up to 25 per cent offshore. And if your time span is only three to five years, Murphy says you are not in a position to assume the currency risk. Murphy says a long-term outlook gives an investor the opportunity to invest in diverse economic cycles. For example, he believes the Japanese market that has been in a downward cycle for 11 years has bottomed and is at a turning point. In comparison the US market has had a bull run for nine years.

 'An investor with all their overseas exposure to the US markets will miss out on the Japanese market when the cycle turns around if they are not invested globally, and will be hurt when the US market falls,' Murphy explains.

Managed funds -Top of Article

It is possible to invest offshore on your own, but you will need a large amount of money plus the time and expertise to analyse world markets.

 You'll need to know about international regulatory, disclosure and tax issues plus, if you want, the ability to manage currency fluctuations. The tax treatment of direct overseas investments are very different than for managed funds and can include foreign investment fund tax (FIF), withholding tax, death duties for amounts over a certain level plus a different tax treatment of capital gains and income from the investments.

 Or you can opt for managed funds. Schoenheimer says that international investment is best left up to managed funds.

But there is a multitude of investment managers with investment processes to choose from. An Australian equity manager might approach investing by making a top-down allocation to favored sectors, then picking the best stocks within those sectors. An international manager has two other important decisions to make from a top-down perspective - country and currency.

 And, just like local investing, there are global equity managers who simply look for attractive companies, regardless of country, currency or sector. So the make-up of their portfolios can be very different from the index.

 Style, whether value or growth orientation, and capitalisation bias, whether large or small cap, are also relevant.

 It is even possible to construct a portfolio with a different basket of currency exposure using currency cross-hedges. So for example a portfolio might be underweight in the US market because of perceived valuation risk, but might have cross-hedged euro exposure to US dollars.

 'It is difficult to determine what is the hedging policy and whether the fund is hedged or not at the moment,' Murphy explains.

 If they do actively hedge, they may have sliding scales of hedging, which can be stopped and started depending on the manager's currency outlook.

 'We don't have faith that currency hedging adds value. Long-term currency is a zero sum game. Someone has to win and someone has to lose,' says Natalie Comino from MLC.

 Murphy says the first decision for an investor is whether to buy a global index manager. He adds that there are some very good approaches in the market. Or, if you want to pay a little more, you can choose an active manager.

 If you select an active approach, Murphy recommends choosing two or three managers each doing the investment differently.

 'I think that the investor chooses a style that they are comfortable with and it is crucial that they ignore the month-by-month, quarter-by-quarter fluctuations and stay with the manager,' he says.

 The investment success of a particular active equity approach over a short period, such as 12 months, may be very much influenced by luck, and over a longer period will depend on the managers' skill at applying his particular process or investment approach. But it is difficult for an investor to differentiate the merits of one approach over another. Comino cautions against chasing the top performers as the past rate of return is no guide to how the investment managers will perform in the future.

 Murphy recommends that the investor call the fund manager, request a copy of the last quarterly report and read up on the fund's top 10 holdings in the portfolio, the business sectors the fund is focused on and what the manager has done in the last quarter. Ask for the performance figures for the past five or 10 years.

 'They will see huge fluctuations up and down over those years and the inadequacy of the last quarter's figures will be obvious,' says Thomas.

 'It will give the investor a better understanding than a cliche label such as value or growth.

 'It is a discipline that takes two phone calls and an hour's reading. It really pays off for investors and they are at a disadvantage if they don't do it,' Murphy says.

 A popular recent trend followed by some Australian-based funds managers is to marry up with an overseas funds management expert giving investors access to researchers who are on the ground around the world.

 Macquarie has teamed with Lazard, Perpetual with Fidelity, Rothschild with Putnam, JB Were with Wellington and MLC with a number of fund managers including Capital International, Vanguard and Fidelity.

 Other fund managers such as BT and Colonial First State prefer to invest overseas themselves. BT has 45 equity analysts working on overseas investments in Sydney who travel extensively. Colonial opened a London office in 1998.

 Schoenheimer is an advocate of the approach whereby the investment manager offers a number of different managers. This is the case with Frank Russell's Gateway range, offered by ANZ.

 'By having a number of international managers representing different styles, you take the bet out of the equation. We want to get rid of the style bias,' Schoenheimer says.

 And if key investment personnel leave, it is easier to switch managers, he says.

 Schoenheimer's advice for the average Australian who does not have enough shares overseas is to get the large cap weighting right first then seek out the second order of investments.

 'Most Australian investors haven't got the overseas investments right. They want the big liquid mature markets, then they should worry about the second order,' he says.

Tax on foreign investments -Top of Article

Part of the attraction of domestic shares lies in the higher dividends - usually 4 per cent - compared with the 2 per cent of overseas companies.

 There are two important different tax structures that apply to overseas investments that do not affect Australian shares. The first is the foreign investment fund (FIF) tax. It was introduced in 1993 by the government to crack down on tax deferral schemes.

 It works this way: an investor has an investment overseas, they must pay tax each year on the investment, even if they have not sold the investment. This is a nasty sting on investors. Unlike capital gains tax that is paid when you sell the investment and have the money, with FIF you have to pay tax when you do not have the cash from the sale on what is known as the unrealised capital gain.

 The good news is that FIF does not apply to some overseas investments. If you buy a managed fund run by an Australian fund manager that buys shares listed on an approved stock exchange such as the New York or London exchange and the company is an active business, then it is exempt from FIF.

 Another exemption from paying FIF is if you invest in US mutual funds. Also if you have $50,000 or less overseas you are exempt from FIF.

 'It is rare that an Australian fund manager would report an FIF tax to clients,' says Brian Bissaker, executive vice president of product development at BT. He says that fund managers have restructured their investment operations around FIF.

 Schoenheimer believes that the Australian Government is guilty of deterring Australians from investing overseas by introducing complex tax arrangements such as FIF and consequently missing out on valuable diversification of assets and the higher returns available offshore.

 'It has cost Australians a lot of money in lost investments. While it may have been a boon for local fund managers and good for the Australian industry, it has been bad for the local investors,' he says.

 If you buy overseas investments directly you could be up for a higher capital gains tax liability on your investment without having the realised profits to pay the tax. If you want to keep your investments simple, it is best to invest with an Australian-based fund manager. 

Calculating the currency factor - Top of Article

Overseas investments offer the potential to increase the total returns from your investments. Natalie Comino, investment research manager at MLC, gives this example.

 If you had placed $10,000 into global shares in December 1979, represented by the MSCI it would have ballooned to $323,287 over 20 years. The same amount invested in Australian shares through the ASX All Ordinaries Accumulation index grew to $146,401 by the end of December 1999. Overseas shares returned an average annual growth of 19 per cent compared with 14 per cent for Australian shares. Over different periods the comparisons can vary.

 Much of the difference in performance between Australian and overseas shares is due to our weak currency. When the Australian dollar falls, the value of overseas assets, expressed in Australian dollar terms, rises.

The world view, as currencies jostle
Market performance for periods ending September 30, 2000
	1 Year	3 Years	5 Years	10 Years
MSCI ($A)	30.5%	23.5%	22.7%	18.7%
MSCI (local currency)	14.3%	14.0%	17.9%	14.3%
S&P/ASX 200	18.5%	10.0%	13.4%	13.4%
S&P/ASX 200 (Industrials)	21.1%	12.3%	17.4%	15.9%
S&P/ASX 200 (Resources)	6.6%	2.8%	3.0%	7.5%
The MSCI numbers are ex-Australia			Source: InTech

The MSCI index calculated before currency effects, referred to as 'local currency', shows what the average of overseas markets has achieved, before the boost of Australian dollar depreciation. Interestingly, these figures are comparable to the Australian market, particularly for industrial shares, and take out the depressed resource sector. For example, over the past 10 years, the industrial index has returned 15.9 per cent, a little ahead of the MSCI (local currency) return of 14.3 per cent.

 Over the past year, industrial shares have significantly outperformed the MSCI (local currency), returning 21.1 per cent compared with 14.3 per cent.

 The Australian dollar has depreciated by about 4 per cent a year over the past 10 years against the US dollar. On a trade-weighted basis the depreciation is closer to 2 per cent.

 The big question is whether this will continue. Some economists are predicting that the current low exchange rate will have a self-correcting effect on Australia's perennial current account problem, and ultimately bring a recovery in the currency. Should this happen, currency effects will be shrinking, rather than boosting, overseas investment returns.

 But investors beware: however tempting, the currency is not a one-way bet.