Overseas vs. New Zealand Investment - Stocks And Fixed Interest.

I argue that for many New Zealanders if your house is here and all your future savings will be from income earned here, then it is odds-on you will be grossly overweight New Zealand and there is no rationale to have another dollar invested here.

Now it won’t always be the case – for instance if you are already retired and most of your portfolio is beyond your house, in a globally diversified set of stocks and bonds, then you may well not be overweight New Zealand at all. Indeed given your possible demand for quite a high income from your investments, you may be best to situate a significant portion of your portfolio in high income yielding instruments – fixed interest or utility stocks for instance. And for those, there is a case for saying New Zealand’s imputation (wherein dividends are effectively only taxed once) rules tend to mean high yielding stocks here are efficient little earners. The case is not watertight – after-tax rates of return will be the same risk-adjusted, whether they’re from New Zealand or foreign stocks. But more importantly this type of investor is a special rather than the general case.

In most cases New Zealanders will be grossly overweight New Zealand in their portfolios – and this arises out of ignorance.

I can hear the conventional objections now;

What matters when you cash in an investment for the purposes of making a purchase, is the price of what you’re buying – not what currency that price is denominated in. More specifically what matters is what determines the price of what you want to spend your money on. And increasingly, in a deregulated market it is global competitive pressures that determine prices. That is the prices of the car you buy, the trip you take, the food you eat is increasingly driven by global, not local forces.

Even the price of a haircut – something we classically see as being determined by domestic factors, is subject to the influences of international trade. If the cost for one gets too high here we will improvise – cut our own, freeing up our budget to spend say on cheaper products from abroad. When there was less choice for consumers – and the scope of competitively priced goods from abroad was not so wide, we just tolerated high prices from protected domestic industry. That has become less and less the case nowadays.

So one has to maximise one's wealth in a way that means we have the most available to buy global products. This implies a portfolio designed to maximise wealth in ‘global dollars’ – that mix of currencies that reflects where we source the basket of goods and services we purchase. And to maximise wealth in ‘global dollars’ requires a global spread of assets. The case for owning predominantly New Zealand assets in a portfolio is very weak indeed.

2. "While an international portfolio of stocks may be prudent, there is no need to hold fixed interest securities anyway but in New Zealand." Wrong again.

The argument arises from the fact that at any one point in time the difference in interest rates between two countries exactly reflects the price of ‘buying forward’ one currency for the other over the same time period. Put another way, if a bank lends you money say in US dollars at 4% for a year, when the interest rates here are 6%, it can immediately protect itself from any currency risk and secure the extra 2% it could have earned by lending in New Zealand dollars, by entering a forward contract to sell the US dollars you will eventually repay it for NZ dollars in the years time. Complicated, but in short it’s a zero sum game.

So it’s argued, you may as well borrow or invest in New Zealand fixed interest as do it in a foreign currency, the return will be the same. But it won’t – forward rates as predictors of the exchange rate have little or no credibility. All they tell us is what the exchange rate that is consistent with today’s exchange rate and today’s interest rate markets is say 6, or 12 months ahead. It is not a guarantee.

So to minimise exchange rate risk on your portfolio of fixed interest securities, you should spread them around the globe, just the same as your stocks.

In summary, we need global portfolios and to contain our exposure to New Zealand within prudent limits. For almost all New Zealanders currently that means redistributing assets from the domestic economy to the global one.

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