Money: All that gold may not glitter

By PHILIP MACALISTER

Australia may look like a glittering prize after its spectacularly successful Olympics, but investors need to be warned that putting lots of their money into that economy isn't necessarily going to produce a gold-medal investment performance.

In recent years New Zealanders have lamented the poor performance of the local sharemarket and looked across the ditch for better returns.

This is an understandable response, particularly as Australia looks to be living up to its "Lucky Country" tag.

It's also an idea which seems to make sense as more and more companies are listed on both the New Zealand and Australian Stock Exchanges, and many companies operate in both markets.

What's more, it's not just the Mum and Dad investors who have taken this approach either. The majority of professional fund managers who offer New Zealand equity funds have expanded their mandates to allow them to consider Australia "home."

A research paper from global investment specialists Frank Russell paints a different picture of Australia.

"We do not believe that exposure to Australian shares is the best way for New Zealand investors to seek better returns," says managing director Dr Craig Ansley.

Dr Ansley's view is one which many New Zealanders may not like, or others may grudgingly be coming to accept: New Zealand is too much like Australia for there to be any major benefit.

"Diversification through international investing should provide both better returns and lower risk as it is precisely the differences, and the low correlation between markets, that provides the real benefit," says Dr Ansley.

Frank Russell looked at how closely the markets have moved together between 1981 and 1999 and concluded that the Australian market has a much higher correlation with New Zealand's than any other.



Dr Ansley says this suggests that the diversification benefits derived from Australia are less than the broad markets and those benefits are reducing over time.

Among the big negatives in the Australasian investment factor is the impact of local tax rules.

One of the best reasons for New Zealanders to invest in their own market is that the imputation tax credit regime provides them with a premium over other investors.

To understand the situation, it is important to recognise that the New Zealand sharemarket has a very unusual characteristic - while most sharemarkets rely on capital growth for returns, New Zealand companies pay very high dividends.

Under our regime, New Zealanders can use the imputation credits attached to those dividends to offset other tax liabilities.

Tower Asset Management believes that without the imputation regime and the high dividend yield there would be no reason to invest in New Zealand shares.

Foreigners buying New Zealand shares cannot use the imputation credits in their own country, meaning their gains from the market will be less than those available to a New Zealand investor.

However, New Zealanders investing in Australia encounter the same sort of problem. Tax credits on Australian shares cannot be used in New Zealand.

Dr Ansley says that even if the much-mooted Stock Exchange merger proceeds, the benefits will not reach their full potential because of the tax situation.

As we have said before in this column, research clearly shows the best long-term returns come from international shares.

Dr Ansley observes that in theory, 70 per cent of a New Zealand investor's exposure to the sharemarket should be overseas.

Such comments are timely following the New Zealand Government's announcement of plans for a multibillion-dollar investment fund of taxpayers' money to help meet some of the future costs of superannuation.

One of the big debates about the fund will be on how many billions of its dollars will be invested in New Zealand.

While Planit Financial Services director Michael Littlewood says that all of it should go overseas, political parties such as the Alliance, the Greens and New Zealand First want a good portion of the money (maybe at least half) invested in New Zealand to help to stimulate growth.

Finance Minister Michael Cullen told a business audience in Wellington that he believed there should be no restrictions.

While there are gaping differences of opinion on how much money should be invested overseas, the research shows that managers are not putting theory into practice.

According to Frank Russell, the median New Zealand balanced fund manager had 28.7 per cent of total assets in overseas shares and 10.6 per cent in international fixed interest.

While the amount is far less than theory suggests is right, the trend has been for a steady increase in overseas exposure as international shares accounted for about 20 per cent of the median balanced fund's assets in 1993.

One of the fascinating aspects of Frank Russell's latest research is that the makeup of the theoretically perfect portfolio has changed significantly in the past 20 years.

From 1980 to 1989 a portfolio made up completely of New Zealand shares would have given higher returns with higher risk than all-international shares or all-Australian shares.

The picture is vastly different for 1990-1999. The all-Kiwi portfolio would have produced the lowest return, plus it had the highest risk. All-international and all-Australian shares had similar returns, but the former had significantly less risk.

The conclusion of the research is that New Zealand investors need to put a significant proportion of their assets overseas.

Assuming you agree, what should you do when investing overseas?

Frank Russell's director of portfolio research, Ernie Ankrim, says there are three investment lessons we are better off forgetting: technology is the only play; growth beats value and large beats small; international diversification means investing in the US.

Mr Ankrim says though technology stocks have provided the best returns in the past five years, the story is vastly different for the past 20 years. In that time the top four market subsectors were transport equipment, tobacco companies, telephone utilities and technology hardware.

The US market has actually been quite volatile, despite everyone thinking it's the only place to be.

Mr Ankrim's third lesson mimics the previous two. In the past five years investors have made the bulk of their money out of large cap and growth stocks. Historically these two investment styles haven't always been the most successful and there is no reason to suggest they will be the best in the future.

It is very hard to predict which areas of the market will do best in a given period, Mr Ankrim says.

"The answer, particularly in times like these, is broad exposure to different investment styles."

* Philip Macalister is the editor of online money management magazine Good Returns. Good Returns provides news on managed funds, mortgages, superannuation, insurance and financial planning.