Canny view: The lesser-known link between investment and return

New Zealand has been on an uphill battle for so long in terms of boosting the nation's productivity. Photo / Supplied

"Investment" actually has two interrelated meanings: a physical investment (machinery, building, cars, etc) and financial investment (stocks and bonds), which lays claim on physical investment and the income (aka "return") it generates.

So what is the lesser-known link between investment and return? Productivity.

Productivity is about how well individuals, businesses, countries combine resources to produce goods and services.

Productive use of physical investment and people are the two most important sources of a country's standard of living, greater wellbeing and directly affects the return we get on the money we save or invest in the country.

The higher the returns, the less we need to save for our future and the more we can consume today. This is especially critical because most developed countries, including New Zealand, have a rapidly growing ageing population. To put things into perspective, by 2036 it is projected around one in 4.5 New Zealanders will be aged 65-plus, which is a 77 per cent increase from 2016.

So productivity matters because it creates huge value in our lives. But New Zealand has been on an uphill battle for so long in terms of boosting the nation's productivity.

We are one of a small number of OECD countries with both a low level of labour productivity and low productivity growth.

Nick Stewart

According to the New Zealand Productivity Commission, New Zealand is unusual in the combination of its distance from international partners, small domestic markets, and industry structure.

This works against the diffusion of new technologies and ideas into our economy and across businesses. In its latest productivity by the numbers 2021 report, the commission pointed that very few New Zealand businesses operate at the global frontier in their industry.

It identified the importance of new technology for productivity growth and attributed New Zealand's poor productivity growth performance to low technological adoption rates and diffusion.

Global audit, tax and advisory firm Grant Thornton's report explained this very well. International connections and innovation go hand-in-hand, each feeding off and driving the other.

A shining example of this virtuous circle is cloud-based accountancy software firm Xero. They worked hard from their early days to make it internationally. This ambition drove them to find ways to do things better, more efficiently, and differently from everyone else.

The biggest problem for investors who get too anchored to familiar companies and loves the comfort of investing in home brands is that not many companies do very well globally.

Let's say you invest heavily in a New Zealand listed company. What difference will that investment make if the business doesn't find a way to create powerful international connections and crack open overseas markets?

New Zealand only accounts for 0.26 per cent of the world economy, but most New Zealand investor portfolios are overly weighted to the home market. In other words, a New Zealand investor with a strong home bias would have just a 7 per cent allocation to technology, compared to approximately 16 per cent in the global portfolios.

It's not that long ago that most Mum and Dad investors' experience with a diversified portfolio was a handful of Telecom, Telstra and GPG shares and for some with longer memories Fletcher Challenge, Chase, IEP and Brierley.

Why might this be?

Given investors tend to source most of their income from their home nation and hold most of their other assets there, you can see that this degree of home bias represents a very big bet on one country, a couple of sectors and a handful of stocks.

So the question then becomes what degree of home bias is acceptable. It shouldn't be surprising that there is no one right answer to that. It depends on each individual investor's tastes, preferences, circumstances and goals.

A good approach is to use a global market portfolio as your starting point.

Suppose you want to increase the expected return of your portfolio. In that case, you can use information in current market prices and company fundamentals to tilt your portfolio towards stocks with higher expected returns. Research has shown that small caps, low relative price and high profitability stocks deliver a premium over the market return.

While you may tilt your portfolio towards New Zealand due to your familiarity with the stocks, it's important to understand this has nothing to do with the expected return of your portfolio. It is just a preference. But it also comes at a cost.

In contrast, broad global diversification creates a portfolio that spreads its risk to more economies, a greater number of stocks, a wider range of companies, and a wider spread of sectors.

Again, there is no single right answer in terms of asset allocation. It will depend on the individual investor's circumstances, goals and risk appetite.

This is where a financial adviser who understands your goals, risk appetites and values can be valuable. An adviser can help you achieve the dual purpose of efficiently considering sustainability and social considerations while building robust investment solutions to grow savings for future consumption.

· Nick Stewart is a Financial Adviser and CEO at Stewart Group, a Hawke's Bay-based CEFEX certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.

· The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz