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How to access global markets in one easy transaction

By James Dunn

Since their arrival on the Australian investment marketplace in 2001, Exchange Traded Funds (ETFs) have proven a hit with local investors, primarily because they offer simple access to a range of different asset classes by buying one product, which is itself a listed stock. In particular, Australian investors have seized on the opportunity to solve one of their most pressing investment problems – the need to diversify their investments outside Australia – by using international ETFs.

Establishing international diversification is vital for Australian investors for two main reasons. Firstly, Australia represents only about 2% of the global stock market by capitalisation, and secondly, the Australian stock market is highly concentrated at the top end. The top ten stocks account for almost half of the Australian market’s benchmark index, and are dominated by banking and resources stocks.

Like their overseas counterparts, Australian investors have a natural “home bias” toward companies they know well, a leaning that is strengthened in Australia by the franking ‘free kick.’

But on diversification grounds, there is a strong argument for Australians owning international shares to give themselves greater exposure to the global economy and to industries and world-scale companies, which their home market does not have. For example, IT, major pharmaceutical stocks and global food companies.

Exposure to international shares using ETFs that track broad indices such as the US S&P 500 has proven highly popular. In particular, Australia’s army of self-managed superannuation funds (SMSFs) has looked to ETFs to access international equities – US and non-US – in a broadly diversified way.

SMSF investors like the broad, diversified international coverage that buying one ETF gives them, particularly when it comes in a cost effective and transparent form compared to the alternative product, which is unlisted international share funds.

The investment management cost is often lower than wholesale managed-fund rates, and investors get diversified global exposure without paying relatively high fees for active management.

The attraction of global ETFs for Australian investors is that they can be extremely cost effective, with no entry and exit fees, and an annual management fee that can be as low as seven basis points (0.07%) a year. Investors will also only pay normal brokerage when buying and selling the ETFs.

The easiest way to establish international diversification is to buy an ETF over one of the large global indices. For example, the iShares Core IWLD ETF tracks the MSCI World Investible Market Index, while iShares IOO tracks the S&P Global 100 Index, an index of the world’s 100 largest companies.

A similar effect can be achieved by buying an ETF over the S&P 500 Index. While this is one of the major indices of the US stock market, you also gain some exposure to the world economy as many of the largest US stocks are global “mega-cap” companies that generate earnings all over the world. This group of stocks contains big consumer-goods companies that represent a play on the emerging consumers in Asia, for example Procter & Gamble, GE and Johnson & Johnson, and also houses the huge technology names, such as Facebook, Amazon and Alphabet (owner of Google). This exposure works for Australian investors on a number of levels.

From first-generation global ETFs, which give access to the recognised mainstream market-cap indices (such as the MSCI World, the S&P 500, and so on), product development has moved through second-generation ETFs, which cover single-countries in both the developed world and emerging markets, and sectors (such as healthcare and consumer staples), into third-generation ETFs. These third-generation ETFs encapsulate exposure to fundamental factor-based or ‘style-based’ strategies.

Targeting particular fundamental or “quality” factors – for example, low-volatility, high-yield, ethical investments – caters for investors who want international exposure but would like that exposure to be designed so as either to maximise, or avoid, a particular factor. For example, the iShares S&P/ASX Dividend Opportunities ETF (IHD) focuses on high dividend paying Australian companies.

Currency is also a big consideration for Australian investors, because buying most global ETFs means taking on the effects of currency movements. If the ETF is unhedged (that is, denominated in a foreign currency), the capital gains and any dividends must be brought back into Australian dollars. That means any gains can be reduced by currency effects – although the opposite is also true.

The good news is some issuers have listed hedged versions of global ETFs, where the exposure is managed and brought back to Australian dollars so that currency fluctuations do not affect the returns. For example, iShares offers both unhedged and hedged ETFs that track the US S&P 500, ASX codes IVV and IHVV respectively. While hedged versions usually attract a slightly higher management cost, it does provide some peace of mind.

Whether it is gaining exposure to the world, a region, a country, an asset class, an industry sector, a currency, or an investing style, ETFs offer Australian investors a simple and low-cost way to invest offshore. Moreover, they can form part of a diversified investment approach to help your portfolio weather the times and generate the best returns possible. Indeed, the benefits of ETFs have already been realised by many SMSF investors looking to access a world of opportunities in one simple transaction.

Published on: Tuesday, July 19, 2016

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