This article first appeared on 15 August 2017 at www.nucleuswealth.com
Investing can be a volatile ride, the last few days have reminded us.
The last few days have also reminded us why holding international equities is often beneficial for Australian investors – the Australian dollar acts as a shock absorber on returns when volatility hits, which is exactly the opposite effect that international investors get investing in Australian stocks.
Let me back up a few steps first to paint the larger picture. The Australian market is viewed by international investors as a “high beta” exposure – when its good its very good, when its bad its very bad.
From the outside looking in
For an international investor deciding between buying Australian assets or international assets, the returns look like this:
Most of this is the currency – as we saw over the last few days when markets fell by 1-2%, the Australian dollar fell a little less, almost doubling the downside for an international investor in Australia.
From a weekly volatility perspective, the volatility in a global portfolio over the last five years (in USD) was 11% vs 18% for an investment in Australia – a stark difference.
From the inside looking out
But this all changes for Australian investors. Perspective matters.
Now the currency acts as a shock absorber:
Source: Factset, Nucleus Wealth
A lot of this is the currency – as we saw over the last few days when markets fell by 1-2%, the Australian dollar fell a little less, almost cancelling much of the losses on international markets for Australian investors in international assets.
From a weekly volatility perspective, the volatility in a global portfolio over the last five years (in Australian Dollars) was 11.8% vs 13.0% for an investment in Australia – a much lower difference. And another win for investing in an international portfolio – international investments have had a lower volatility despite (actually because of) the currency effect.
Past performance is not future performance
Now, I hasten to add that this is historical and relationships do change. But this is not a relationship that I expect to change over the next few years – in fact, it is a major reason why we are heavily overweight international stocks in our portfolios.
I can’t tell you what Trump will do next or whether we all should be going long fall-out shelters and potassium iodide.
If we are headed for war, then bonds, not stocks are the place to be. A nuclear war is not our base case, but we are expecting the ride to be a lot smoother (for an Australian investor) in international stocks than in Australian stocks regardless.