Saturday, 16 October 2010

Strong Aussie - Time to Buy Foreign ETFs?

The Australian dollar has now reached parity with the US dollar, meaning that one Australian dollar equals one US dollar. This is the first time this has happened since the Australia dollar was floated way back in 1983.

Many Australians are taking advantage of the strong Australian dollar by going on holidays overseas. Perhaps one good idea is to take advantage of the strong Australian dollar by buying other countries' shares. Exposure to foreign shares can easily be achieved via iShares' range of foreign ETFs.

Looking purely at the dividend history of these foreign ETFs, the best is the iShares MSCI Singapore ETF, which has distribution rate of 5.22% so far. The Australian dollar has indeed been strengthening against the Singaporean dollar for the past year. The Singaporean economy has been the fasting growing in the world post-GFC. The country seems to be ruled by very competent people and the population seems to be highly educated, although my discussions with people suggest that the Singaporean education system does not foster critical thinking. This lack of criticial thinking is evident in the fact that even though most Singaporeans have a lot of faith in their country's economy they are mostly unaware that Singapore has one of the world's highest public debt. The size of the public debt is greater than the size of Singaporean GDP. In Singapore's defence, I was told that much of this debt is held by Singapore's pension funds. That is, most of the government debt is held by Singaporeans. In America and Greece, much of the government debt is held by foreigners. I am not entirely sure how this makes a difference. The problem with government debt is that it needs to be paid off in the future, which means higher taxes, which slows economic growth. However, Singapore has a very large sovereign wealth fund (Temasek Holdings), so rather than resorting to high taxation to fund their debt, they can use their investments. Singapore's level of taxation is currently phenomenally low, especially compared to countries like Australia and the US.

Even if Singapore's government debt may not be a problem, there are other risks with investing in Singapore. An investment in iShares MSCI Singapore ETF exposes you heavily to the finance sector. A browse of the holdings of this ETF reveals that many of Singapore's largest listed companies are holding companies, banks, and real estate trusts. Buy buying into Singapore you are not really getting that much diversity in terms of sectors. Singapore's focus on finance takes it heavily dependent on other economies and can even, in my opinion, make Singapore's economy rather correlated to Australia's economy. After the GFC, Australia's economy rebounded strongly and currently interest rates in Australia are very high, much like interest rates in Singapore. Australia and Singapore seem very similar in that both are trade-focused and heavily dominated by the finance sector. Both the countries have increasing real estate prices. The main difference is that Australia has a massive resources sector while Singapore does not.

Unlike Singapore and Australia, Europe and the US has been dropping its interest rates, and the US has resorted to printing money to stimulate its economy. This has led to a devaluation of the US dollar to other currencies. This is a great opportunity then for Australians to buy American shares. Currently corporate America is paying virtually nothing in terms of divdends, so a better alternative is to buy the iShares S&P Global 100, which invests in 100 large, multinational companies. The benefits of investing in this, in my opinion, is that you are investing in very high-quality, internationally recognized companies. Most of these companies are European and American, meaning you buy for cheap in the countries that are hardest hit by the GFC. This then allows you to truly diversify your portfolio if, like mine, it is overweight in the shares of high-risk, high-interest rate countries like Australia. The yield on the Global 100 ETF is around 3 or 4 per cent, which is not bad but not as good as Singapore or Australia. If the Australian dollar does take a hit, investment in this ETF should pay off.

The argument for investing in the US now is that all the money printing will eventually jump start the economy again and once that happens, the American dollar will regain its strength. This is the argument put forth by Peter Switzer, the permabull, who in an piece in Yahoo!7 Finance titled Ignore Bears, But Not History, says the following: "I'm an optimist and trade long only and so I search for confirmation that my investment strategy is right." Is this guy crazy or what? You don't choose to be an optimist and then collect evidence to prove you are right. You look at the evidence first and then based on the evidence make a decision about whether you want to be optimistic or pessimistic. That is how a proper investor should behave.


Josh said...

On the money i think. What do you think about using CFDs to target specific US stocks that will benefit from a low USD. Exporters? Not sure which stocks they are and i dont have a CFD account but i like the idea :)

Anonymous said...

Hey Josh, I don't have a CFD account either but from what I heard you can achieve massive leverage with CFDs. Given the Aussie is strong then I think using CFDs would be a good great idea as you get more leverage, but watch out as leverage can magnify your losses if for example the Aussie dollar were to continue to strengthen!

Anonymous said...

Correction - US exporters would suddenly perform poorly if the American dollar were to unexpectedly strengthen. Some financial commentators like Peter Switzer believe that money printing will jump start the American economy, which will in turn strengthen the US dollar. Sounds a bit crazy to me but who knows maybe the weak dollar will help pay off the US's debt and may even increase inflation and hence spur people to work more out of desperation.