The underperformance of Australian equities in the last year has highlighted the importance of diversifying globally for all Australian investors, not only to seize opportunities but to avoid being overexposed to local risks. However, we believe most Australian SMSF investors have very low allocations to international equities, particularly relative to the average large superannuation fund.
Why is that?
In spite of the diversification benefits of investing in foreign shares, it seems investors have a tendency to over-invest in domestic market. This home bias is likely due to two reasons; firstly that people tend to invest in what they know, and secondly, because of the perceived difficultly and associated costs with accessing the global market.
Investments in Australian shares can carry valuable franking credits. The franking credits on the Australian S&P200 index for FY2016/17 were worth 1.4% in returns for a pension phase superannuation fund which receives a full refund of those franking credits. For a pension fund, this meant Australian shares returned 5.7% for FY2016/17. On the other hand, investments in overseas shares can often be subject to foreign government withholding taxes which can reduce the dividends and thus total returns that investors receive.
Australian shares have delivered higher dividend yields relative to global shares in the past. For example, Australian shares yielded 5.7% inclusive of 1.4% franking in FY2016/17 whilst global shares yielded just over 1.9% after withholding taxes. From an income perspective, Australian shares appear to be more attractive than global shares. However, we believe it is possible to generate similar levels of income from global equities if a fund is actively managed for income
Australian equities: Consider the risks
Focussing on domestic shares makes sense at a number of levels, but it could result in missed opportunities, as well as increased exposure to significant risks.
Chart 1 - Top dividend payers in the S&P/ASX200 in FY2016/17
Source: Plato, Iress
The chart above highlights the concentrated nature of the Australian equity market. Of the 200 stocks in the S&P/ ASX200 index,
the top six stocks represented over half the total gross dividend income in FY2016/17.
With the four big banks currently representing approximately one third of that dividend income, if a banking industry incident were to occur, this could seriously impact the total dividends paid on the Australian share market, and in turn the income received by the average SMSF.
Therefore, income-focused SMSF investors should consider high-yield global share offerings to not only generate income streams, but to also diversify away from the $A, particularly those in pension phase.
The benefits of high-yield global share offerings
To provide a contrasting measure of how concentrated the Australian equity market is, we calculated the dividend composition for a global equity index, depicting the top six dividend paying stocks in the MSCI World ex Australia in FY2016/17.
Chart 2 - Top dividend payers in the MSCI World ex Australia in FY2016/17
As shown in Chart 2,
the top six stocks represent less than 10% of the total dividends of the global index in FY2016/17,
and the make-up of those top six stocks is far different to Australia’s top six stocks. The top six reflect globally recognisable brand names in industries such as energy, electronics, software and telecommunications.
It is evident that the income derived from the global index is likely to be more diversified, and therefore not dominated by a single industry in a single geographic location, like the Australian banking is to the Australian index.
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