Global options: Susan Hely Picking the winners

As well as much-needed diversification, overseas stocks can provide stronger returns, though the winners are getting harder to pick

Overseas shares are on investors’ radar because of some impressive returns, particularly from the US market. The S&P 500 is up 13.6% over the year, twice the return from the S&P/ASX 200. If you held shares in the technology-heavy NASDAQ , the return was 21%.

In the search for investment opportunities, 52% of financial planners view global shares as the best prospect for their clients, according to a poll of 800 planners at a recent Morningstar investment conference. Only 14% of planners see Australian equities as the best future investment.

Also 28% of self-managed super funds (SMSFs) plan to invest in international shares in the next 12 months, up from 18% a year ago, according to an SMSF report by Vanguard and Investment Trends.

The case for going global appears compelling. For a start, Australian investors are not as diversified as they should be. Australia accounts for less than 2% of the world’s investment markets and the S&P/ASX 200 is heavily skewed to two sectors – financials and materials – which make up more than 60% of the market cap of the top 200 companies on the ASX. There aren’t a lot of technology and pharmaceutical companies listed in Australia but there are on certain overseas exchanges.

Yet SMSFs have traditionally shunned international shares, preferring the solid income stream from Australian share dividends with their attractive franking credits. Non-SMSF investors typically hold some overseas investments in their super (around 25% to 30% in a balanced fund), including emerging markets.

But the big debate among investment experts is whether the time is right to start investing globally. Certainly the US market has been a strong performer with a 12.8%pa gain over the past five years, resulting in highly priced shares. This has prompted fund managers such as Templeton Global Equity Group to sell down its exposure to US stocks to a third of its global portfolio at a time when the US makes up 50% of the global markets, according to portfolio manager Peter Wilmshurst. Templeton has switched to better-priced markets such as Europe and Asia.

Simon Doyle, head of fixed income and multi-asset at Schroders, says markets are transitioning from low inflation and good growth to a different investment climate characterised by a lot more uncertainty. He expects low returns to continue from most asset classes over the next three years. “We are entering a time when the best of the returns are behind us. We are not falling off a cliff but it is getting harder to pick the right assets. We are not at the precipice yet.”

There are a number of ways to buy global investments. You can buy them directly or invest in a pooled managed fund or an exchange traded fund (ETF).

DIRECT SHARES

You can buy direct shares through a traditional broker or an online broker such as CommSec, which allows direct trading and tracking of shares on 25 global sharemarkets including the New York, Tokyo and London stock exchanges.

An advantage of buying through a broker is the access to sharemarket and stock news and setting up a watch list for international shares. “Getting access to information nowadays is pretty easy,” says Wilmshurst. “You can get company results, PowerPoints and research but the problem is that you are drinking from the fire hose – there is an overwhelming amount of information.

“It is one thing to find the company you like but another thing to understand the context around it. What is going on with the economy and fiscal policy and what is happening in regulation? The problem is there are so many companies and opportunities. Which one do you choose?”

One strategy is to pick off the big brands such as Amazon, Netflix, Google and fashion labels such as Gucci and Prada but Wilmshurst says this can be fraught with risk. Just because they are well known and have performed in the past doesn’t mean they will do so in the future.

He says investors buying direct shares face administration difficulties even though it has become easier over the years. There are currency issues, tax and different reporting periods. “It is still a burden to have to buy shares directly.”

One of the downsides of buying direct global shares is the taxation treatment, which is different from investing in Australian shares. It can vary depending on your individual circumstances.

Typically, the broker will ask you to complete a US tax form, known as a W-8BEN, as part of the application process for setting up an international trading account. This

form is valid for three years – unless there is a change in circumstances – and allows foreign investors to claim special tax treaty benefits, including a reduced rate of withholding tax of 15% on dividends.

If you do not have a valid form, you will be charged 30% on sale proceeds and dividends. This means that 30% of any payments to your international trading account may be withheld to cover the US Treasury’s withholding tax liabilities. The fees and brokerage rates are higher for overseas shares than for local ones. For example, CommSec charges $US39.95 ($55) or 0.40%, whichever is greater, for purchasing shares on the Canadian, Asian, European, Middle East or New Zealand exchanges. In Canada, there is an additional 0.15% executive fee while the other exchanges typically charge taxes and market fees.

There are foreign exchange fees that are around 0.6%. The currency has to be transferred from US dollars and incurs an additional spread fee.

Currency is a key consideration for investors in overseas shares. Volatile markets mean currency can fluctuate significantly. Trying to judge what the Australian dollar will do is difficult. Investors can choose a fund with hedging or go unhedged.

MANAGED FUNDS

If you don’t want the administrative hassles of buying direct shares, you can buy either unlisted global managed funds or listed exchange traded funds. You pay for the fund managers to manage the tax, decide the currency risk (hedge or unhedged) and pick the investments.

Most investors don’t have the skills to succeed at market timing and selecting and transacting a portfolio of global shares, so often it is better to leave it up to the experts. You can buy instant diversification to international shares, sectors and markets with an international managed fund or a low-cost ETF listed on the ASX.