The decision to invest globally is one that all investors will face at some point. And for investors based in relatively small economies like Australia – which represents less than two percent of global gross domestic product – this decision is even more important. The case for investing a significant share of one’s portfolio abroad is strong. There are two key reasons: (i) the opportunity set is so much larger; and (ii) the portfolio diversification benefits to one’s portfolio from investing abroad – both in terms of business value drivers and underlying currency exposures – are significant and cannot be replicated by investing in domestic assets alone.
But for many Australians who have little desire to travel abroad, is it really necessary to invest globally? After all, if you live only in Australia, your expenses are in Australian dollars and you do not need to worry about global diversification. Or so the conventional wisdom goes.
This could not be further from the truth. It may surprise many to learn that households are, in fact, net importers of goods. Even though everything you buy for your house is purchased with Australian dollars, the true underlying source of the goods is, in many cases, from abroad. Whether a car, fuel, clothes, an iPhone or even TV shows watched on Netflix: in many cases these have all been sourced from abroad. And this means that all households need to worry about preserving their global spending power – just as any importer would.
A clear illustration of the impact of this concept occurred in the UK last June. When the “Brexit” referendum results came in, the Pound Sterling collapsed by more than 10 percent in a matter of hours. And just three months later, Apple raised the price of its iPhone 7 by £100. Why? So that Apple could maintain its iPhone price in US dollar terms.
Every Briton who believed all their expenses were exclusively in their domestic currency and did nothing about it, experienced a genuine erosion of purchasing power. Their iPhone just became significantly more expensive. And the same was true for many goods purchased by UK households.
Another example relates to the impact of President Trump on Australian investors. Now many Australians view US politics as little more than a source of fascination, though few believe there is much in the way of tangible near-term economic consequences. But for any Australian with a mortgage – and there are a quite a few with many – the result of the US general election last year will be felt very soon, if it has not already. Here’s why.
The US election resulted in the surprise combination of one party – the Republicans – controlling the White House, the House of Representatives and the Senate. This means that meaningful new laws can and will be passed, undoing the gross dysfunction that plagued the Congress for the prior six years. This resulted in an immediate uptick in expectations of some form of fiscal stimulus – be them tax cuts, infrastructure spending or regulatory easing. And these expectations, in turn, translated into higher inflation expectations; which, in turn, pushed up medium and longer-term US interest rates.
But what does this have to do with the Australian economy? Well, it turns out that much of our banking system is financed by the US. So as interest rates in the US rise, to too will mortgage rates in Australia. And this will affect every Australian with a mortgage.
We might live on an uninhabited island far away from the rest of the world. But like it or not, our economy is globally connected. And Australians need to keep this in mind when they are considering where to allocate their investments.