Tuesday, 17 January 2012

Investing in foreign index funds: the exchange rate opportunity

As I have mentioned in a previous posts, when your home currency is particularly strong (like the Australian dollar currently is) it makes a lot of sense to invest your money in overseas markets. The strong currency, especially if significantly overvalued, offers a great hedge against bad market performance.

For me personally, there is a double benefit. International markets (e.g. US, UK, Europe) have significantly underperformed the Australian stock market in recent years due to recessions in those markets (and the GFC) while there has been a mining / China related boom in Australia. That is not to say that these markets are cheaper on a multiples basis - the Australian market is actually cheap on a relative basis due to the high earnings levels. However currently risk in the Australian market is on the downside while many international markets offer significant upside risk.

What I mean by that statement is that although companies in Australia look cheap no their current earnings, the resources earnings are dependent on China. If China slows, these earnings slow which impacts the sentiment in the whole market and affects stocks totally unrelated to the mining sector. On the other hand given the low growth in the US / UK due to continuing threats of recession, the companies in these markets look relatively expensive based on current earnings. However the risk (measured as volatility) is on the upside (except Europe which is a special case) so if you're not looking for short term returns, the recovery in these markets could offer a very attractive return.

If my home currency was at fair value against the USD or GBP it probably wouldnt be worth the risk for me. I don't have time to keep track of these markets as well as my home market. However given how overvalued the currency is it provides a buffer against a downturn. Further by investing through an index ETF you're getting the total market return which means that you can just concentrate your efforts on the currency performance as there is no stock specific information that you have to keep a really close eye on.

The easiest way to invest in foreign index ETF's is to see whether there is one listed on your home market. iShares offers a wide variety of low cost ETF options. In Australia they have an S&P500 ETF (ASX:IVV), a Nikkei ETF (ASX:IJP) and various others. The key thing to look for is to make sure that there is no currency hedging. This totally removes the benefit of your strong local currency. If there is no ETF in your home market (e.g. there is no FTSE index listed in Australia) you may need to invest in an ETF on a foreign exchange. If you have a cheap international broker like Interactive Brokers this should not be an issue.

In my next post I will give an example of how I went about investing in a foreign ETF.

No comments:

Post a Comment