Diversification in practice: Investing from Australia

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daffyd
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Diversification in practice: Investing from Australia

Post by daffyd »

I've been trying to achieve personal clarity on diversification so decided to write things down. The following short novel discusses the challenges of diversification in Australia (or to a great extent most small markets) and some of the products available to mitigate those challenges. To be clear (and I reiterate below) I'm assuming the reader knows Superannuation is the most effective 'container' we have to save for a retirement income stream, and that Fixed Interest (be it in bonds or online savings accounts) is a more important source of diversification/stability than slicing and dicing equity. It would be great to get feedback, particularly from Australians and those investing from other small markets, as well as believers in factor tilts elsewhere.

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The Australian stock market is extremely concentrated (in the ASX300 the top 8 stocks are about 50% of the capitalisation weight, the top 25 stocks about 71% and the top 50 stocks about 83%. For comparison, at time of writing, the S&P 500 has about 17% weight in its top 10 holdings based on the ETF VOO). The ASX300 also has some relatively high industry concentrations (around 45% in financials including property trusts, of which 30% is in four banks, and 17% in materials i.e. mining).

So holding an ASX200 or ASX300 index fund or ETF gives less diversification than one might imagine from the headline number of stocks. While this problem is not unique to Australia (e.g. Canada, New Zealand, small developed European nations such as Finland), among such affected countries Australia and New Zealand are geographically isolated; A Canadian investor may be relatively more comfortable investing in the US and a Finnish investor investing in other European nations such as Germany, while Australia has fewer 'comfortable' options.

This note outlines the strategies and products currently available in the Australian market for those who want a significant exposure to equities but want to diversify past the top 25 ASX stocks. Most investors should also have an allocation to Fixed Interest (Australian bonds, term deposits and/or high interest savings accounts). Also, most Australians investing for retirement will be best off focusing on asset allocation within Superannuation before worrying about other investments.

Geographical Diversification
The most efficient choice is an allocation to international shares, and a degree of this is increasingly common (in particular most default superannuation funds will include international shares). While Australia is only ~3% of world equity markets it is rare that an individual or super fund has more than 50% of equities outside Australia. There are some good reasons for a little home bias:

- Australian residents (and our super funds) are usually eligible for franking credits from dividends. In our superannuation funds this will often reduce the overall tax paid on earnings of the fund and so increase after-tax returns
- Currency fluctuations can also impact international share returns in Australian dollars. However in an international fund hedged to the Australian dollar, imperfect currency hedging can be a drag on returns (and lead make it more difficult for a manager to track their index). Over the long term this should average out, so is more an issue for those close to or in retirement (i.e. actually spending those returns in AUD).

Then there's the more behavioural reason: tracking error. Australians may just be more comfortable with local shares, much like investors in most other countries (including the US) suffer from a degree of home bias. This may be less of a 'rational' reason, however if behaviourally a proportionally large international share allocation will limit one's ability to stay the course in rough times then it may be reason enough to have some home bias.

To invest in international shares, the easiest way will likely be in a Superannuation fund (I use SunSuper who have relatively low-fee International Enhanced Index funds available. Most diversified/balanced/conservative/growth funds will include an international allocation). Outside of super there are relatively expensive index funds (e.g. Vanguard or Colonial Wholesale) and ETFs (relatively inexpensive but incur brokerage, e.g. Vanguard or iShares products if comfortable with taxation implications of a US-domiciled fund or SPDR products such as WXOZ if not).

Example ETFs and Unit Trusts: ASX200/ASX300
Vanguard® Australian Shares Index ETF (VAS) - 0.15% Expense Ratio
SPDR® S&P®/ASX 200 Fund (STW) - 0.29%
iShares MSCI Australia 200 (IOZ) - 0.19%
Colonial First State Wholesale Index Australian Share (Unit Trust) - 0.41%
Vanguard® Index Australian Shares Fund (Unit Trust) - 0.75% (0.50% for amounts >$50,000)

Example ETFs and Unit Trusts: Large Cap International
SPDR® S&P® World ex Australia Fund (WXOZ) - 0.42%
Colonial First State Wholesale Index Global Share (Unit Trust) - 0.53%
Vanguard® Index International Shares Fund (Unit Trust) - 0.90% (0.60% for amounts >$50,000)
or US-domiciled ETFs split into US/non-US (Note VEU includes Emerging Markets while WXOZ and IVE do not)
Vanguard® US Total Market Shares Index ETF (VTS) - 0.05%
Vanguard® All-World ex-US Shares Index ETF (VEU) - 0.15%
iShares Core S&P 500 ETF (IVV) - 0.07%
iShares MSCI EAFE ETF (IVE) - 0.34%


Once we've taken our International Shares allocation up to the level we can sleep well at night we may decide we have enough diversification, in which case we can choose specific products to implement our plan. However we may still be left with large individual stock and industry concentrations if we were to invest the remainder of our equity allocation in the ASX200 or ASX300. The rest of this note focuses on other Australian equity product classes to cover this case. I'll work in order of costs - we're Bogleheads so cost matters.

Old-School LICs and Alternative Indices
Before there were index funds in Australia there were Listed Investment companies. These close-ended funds are still popular, with the biggest (AFI, ARG, MLT) trading above their NAV (Net Asset Value) during 'good times' (and surprisingly even sometimes during bad: see the charts in the link to reports below).

The old LICs have a good record of results in line with their indices and low fees (the three largest noted above all charge less than 0.20% p.a.). They typically offer fully-franked dividends. Newer ones are much more variable, ranging from actively managed small cap to international value and market neutral funds (i.e. typically not very Bogle-ish).

Their performance has tracked their indices pretty well and there's not much bad to say about the old reliable LICs except most of them currently trade at a premium to NAV and they don't really offer much diversification over an ASX300 fund like Vanguard's VAS ETF (expense ratio 0.15%) or the SPDR STW ETF (0.29% but the largest, oldest and most liquid ETF in Australia)

There are also some other large cap index options including a couple of RAFI Australian Large Cap. However while the idea of fundamental indexing is appealing in practice the degree of concentration looks remarkably similar to the ASX200. The high dividend ETFs available aren't ideal, as most of them are even more overweight the same banks. The one dividend fund which caps industry and individual stock weights (iShares' IHD ETF) recently distributed an enormous capital gain so may be a little risky in terms of tax impact outside super. There's also a large cap value ETF but again this overweights the banks.

Ultimately most of these large cap ETFs and LICs seem more like alternatives to the cap weighted fund rather than providing diversification beyond a core index, so don't achieve the aims for diversification set out above.

Examples: Large Listed Investment Companies
Australian Foundation Investment Company (AFI) - 0.19% Expense Ratio
Argo Investments (ARG) - 0.18%
Milton Corporation (MLT) - 0.16%

Examples: Alternative Large Cap Index Funds
BetaShares FTSE RAFI Australia 200 ETF (QOZ)- 0.30%
Realindex Wholesale Australian Share (Unit Trust) - 0.65%
iShares S&P/ASX Dividend Opportunities Fund ETF (IHD) - 0.30%
Vanguard Australian Shares High Yield ETF (VHY) - 0.25%
Russell High Dividend Australian Shares ETF (RDV) - 0.34%
SPDR MSCI Australia Select High Dividend Yield Fund (SYI) - 0.35%
Russell Australia Value ETF (RVL) - 0.34%


Australian Real Estate Investment Trusts

Another popular alternative is to include an allocation to Australian REITs. Note that these are already included in an ASX200 fund but at a much lower weight. Also, the tax implications require more keeping-track than standard dividends (see links at the end of this note) so may be best suited for an allocation inside super.

My main question about REITs is: how much diversification do we really get from them given our already large allocation to banks and financial institutions? Another concern is that the funds themselves are not very diversified (the Vanguard ETF holds 27 securities, with 87% of the fund's assets in the top 10 holdings). Market Vectors have recently introduced an ETF with capped individual holding weights which mitigates this issue, but only slightly.

Given the lack of diversification in the funds themselves it's hard to recommend them as a large proportion of an overall portfolio. A very small allocation seems reasonable if this segment appeals.

Examples: Australian REITs
Vanguard® Australian Property Securities Index ETF (VAP) - 0.25%
Market Vectors Australian Property ETF (MVA) - 0.35%
SPDR® S&P®/ASX 200 Listed Property Fund (SLF) - 0.40%
Colonial First State Wholesale Index Property Securities (Unit Trust) - 0.41%
Vanguard® Index Australian Property Securities Fund (Unit Trust) - 0.90% (0.60%)


Small and Mid Cap Indices

The tilters in the audience may be wondering why we don't just use a Small Cap Value index fund, given the factor diversification it should offer. Unfortunately a low cost Small Cap Value fund is not available in the Australian market - even DFA only offer separate Small Cap (Blend) and Large Cap Value funds here.

As discussed above, Large Cap RAFI and Value funds may be reasonable substitutes for an ASX200 fund but aren't likely to achieve the objective of more diversification. So what is available in the small and mid-cap space?

For the most part, Small Cap index ETFs follow the small ordinaries index. Unfortunately it appears Australian small cap managers do the unthinkable: reliably beat the index. While large cap and other segments show results consistent with international experience (e.g. US and International SPIVA scorecards and the many books and papers we treasure) the Australian SPIVA scorecard has consistently shown small cap managers beating the Small Ordinaries Index after expenses, even correcting for survivorship bias, year after year.

The standard suggested reasons can be brought out: the stocks are less researched by institutions, large funds are unable to invest in them due to liquidity and impact costs, speculator's preferences for 'lottery' stocks, maybe they're just not small enough. But perhaps it is just an immature market for small caps and will be arbitraged away eventually.

So what is a Boglehead who wants to diversify into small and mid-cap stocks to do? I've only found a few options reasonably consistent with a passive 'tilt'. Market Vectors has a relatively new Australian Equal Weight ETF. It's probably too new (with too few assets to ensure it will survive) but at least offers significant weight towards the bottom 50 of the top 75 or so stocks. The big risk is turnover (they estimate at around 25% p.a.) and resulting costs and distribution of capital gains. The previously mentioned iShares IHD ETF also has more mid-cap exposure than the ASX300 (but see the earlier note about a large recent capital-gain distribution).

The closest we get in Australia to a small cap value index fund is the Realindex Wholesale Australian Small Companies. This RAFI Small Cap fund has a few years now of solid performance (but standard caveats about past performance are important to remember). My concerns about the fund are the relatively high fees (0.86% p.a.) which may lead to capital gains lock-in, and the potential for high turnover. The issues of capital gains lock-in (where it is preferable to stick with an expensive fund even if cheaper funds become available in the future due to capital gains taxes) and turnover (with capital gains distributions) are less of a concern within superannuation where the fund can be held at a cost of 0.89% p.a. At that price it would be hard to justify a large allocation.

Examples: Australian Small Cap Index ETFs
Vanguard MSCI Australian Small Companies Index (VSO) - 0.30%
SPDR S&P/ASX Small Ordinaries Fund (SSO) - 0.50%
iShares S&P/ASX Small Ordinaries ETF (ISO) - 0.55%

Examples: Alternative Small Cap (and Mid-Weighted) Index Funds
Market Vectors Australian Equal Weight ETF - 0.35%
iShares S&P/ASX Dividend Opportunities Fund ETF (IHD) - 0.30%
Realindex Wholesale Australian Small Companies (Unit Trust) - 0.86%

Everything else

Individual stocks can be purchased but we are Bogleheads. It is very hard to justify the idiosyncratic risk.

Commodities: Zero expected return is a real turn-off and the diversification benefits are unclear.

Direct property: see individual stocks but add in liquidity issues and information challenges.

Actively managed funds are as ever hard to justify. Large Cap funds do not consistently beat an index fund. Small Cap funds are a tricky proposition: until recently I would have said their expenses (typically 1-2% plus 15-20% of performance above benchmark for those who don't just hug an index) were ridiculous enough that investing in them was inconceivable. There have been a couple of floats of Listed Investment Companies recently that are priced in-line with the Realindex Wholesale Australian Small Companies fund so perhaps competition will bring prices down.

[If curious, certainly not a Boglehead choice, QVE is a value manager focusing on the ASX300 excluding the top 20 names. They are charging 0.9% for the first $150m Assets Under Management and 0.7% above that, and floated with $180m in assets. They listed on 22nd August.
FGX plan to float in early September and will invest in existing unlisted funds from their sponsors. The draw of FGX is the associated fund managers have agreed to waive their usually substantial fees and in lieu of those fees the fund will donate (to begin with) 1% p,a, of AUM to kids charities. Full disclosure: I have applied for a small holding in FGX. There goes my Bogle-cred.]

Anything more complex than International, REIT and Small Cap allocations is unlikely to be profitable on a risk adjusted basis. There is an argument that unlisted property and infrastructure may access an illiquidity risk premium but that is by no means certain (see Ang (2014)) and will be challenging for individuals to access profitably outside of a small amount in Industry Superannuation funds.

Conclusions and hopes for the future

So, what is an Australian equity investor who wants more diversification to do?

Based on the above, start with International share allocation within superannuation, International index funds and ETFs. Bring that up but not to a level where you can't sleep at night.

If that doesn't provide enough diversification, look at a small allocation to REITs (preferably in super), a Small Cap or alternative Small Cap (or Mid-Weighted) index fund.

All this may all be most relevant to those in the middle of their lives. For the young the rate of savings and an ability to stay the course are more important than the precise allocation, and currency risk should not be an issue over such a long timeframe. In retirement a proportionally smaller equity allocation may limit the impact of further diversification within the equity component of one's portfolio.

As for the future, we are already seeing an increase in the options available and signs of fee competition amongst active managers. While the dream scenario for tilters of a low-cost small cap value index ETF may never exist due to the level of interest in such a product from the general public and the liquidity of the underlying stocks (if there isn't one available for the larger UK market it's not really surprising there isn't one here) one possibility that I can imagine is a "Mid-Cap" ex-20 (or ex-50) ETF. This would invest in the ASX200 or ASX300 stocks excluding the top 20 (or 50), ideally with "buffers" to limit turnover. Funnily enough you can already get an ASX "Mid Cap 50" ETF (covering stocks 51 - 100) in New Zealand, just not Australia. Given the popularity of recent Listed Investment Company floats in the Small and Mid-Cap segment there may be a market for such a product.

In the mean time, we now have low-cost access to Australian and International Large Cap index products both inside and outside Superannuation, already a great improvement from the expensive active management that preceded it.

Links:

Vanguard on home bias:
https://pressroom.vanguard.com/content/ ... e_Bias.pdf

Reports on Listed Investment Companies: http://www.wamfunds.com.au/WAM-Capital/ ... ports.aspx

Tax differences for REITs: http://www.asx.com.au/education/investo ... -reits.htm

SPIVA Australia Scorecard: Active management vs. indices http://au.spindices.com/resource-center ... hip/spiva/

Ang (2014) refers to Asset Management: A Systematic Approach to Factor Investing, 2014, Oxford University Press. Chapter 13 on Illiquid Asset Investing has been made available for download by the author at: http://papers.ssrn.com/sol3/papers.cfm? ... id=2200161
AlohaJoe
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Re: Diversification in practice: Investing from Australia

Post by AlohaJoe »

A nicely detailed post. The only thing I'd really add is that I think you go past international diversification too quickly. For the reasons you outline I don't find REITs or mid/small-caps terribly appealing as a diversifier. Vanguard's Small Cap ETF only covers 162 companies. I haven't seen any maths but that doesn't feel like I'm buying much diversification :?

I've always been dubious about how much weight to give franking in Australia. I know of one paper that found that franking was only valuable to shareholders in smaller firms, and not those in top 100 firms. And since those firms make up the majority of the ASX....I've also read that it adds 2-3% return.

If I take the 2-3% as an upper end, would I be willing to trade off 3% for more diversification outside of Australia? Probably.

Rather than mucking around with REITs or small-caps I reckon Australian investors should just increase their international component.
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in_reality
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Re: Diversification in practice: Investing from Australia

Post by in_reality »

daffyd wrote: While the dream scenario for tilters of a low-cost small cap value index ETF may never exist due to the level of interest in such a product from the general public and the liquidity of the underlying stocks
AlohaJoe wrote:Rather than mucking around with REITs or small-caps I reckon Australian investors should just increase their international component.
I think you are both right. Why not add in iShares Enhanced International Small-Cap IEIS (0.49%ER) (or similar fund).

You get Australian small cap value exposure up to Australia's market weighting!

I'd worry only Australian small caps and REITs would be too highly correlated to large caps.
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SimpleGift
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Re: Diversification in practice: Investing from Australia

Post by SimpleGift »

daffyd wrote:To invest in international shares, the easiest way will likely be in a Superannuation fund (I use SunSuper who have relatively low-fee International Enhanced Index funds available. Most diversified/balanced/conservative/growth funds will include an international allocation). Outside of super there are relatively expensive index funds (e.g. Vanguard or Colonial Wholesale) and ETFs (relatively inexpensive but incur brokerage, e.g. Vanguard or iShares products if comfortable with taxation implications of a US-domiciled fund or SPDR products such as WXOZ if not).
Though Australia is certainly considered a developed market, I've read that its stock market is increasingly correlated with emerging markets, especially China and Asian emerging markets. With such a large proportion of Australia's exports now going to Asia (more than 50%, I believe), this is not surprising.

As a result, it would seem Australian investors would want to concentrate on just international developed markets (U.S., Europe and Japan) when allocating the international equity portion of their portfolio — and avoid any mutual funds or ETFs that have significant emerging market exposure. Just a thought.
Tonen
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Re: Diversification in practice: Investing from Australia

Post by Tonen »

A great writeup daffyd. It's going in my bookmarks.
daffyd wrote:Australian Real Estate Investment Trusts

Another popular alternative is to include an allocation to Australian REITs. Note that these are already included in an ASX200 fund but at a much lower weight. Also, the tax implications require more keeping-track than standard dividends (see links at the end of this note) so may be best suited for an allocation inside super.

My main question about REITs is: how much diversification do we really get from them given our already large allocation to banks and financial institutions? Another concern is that the funds themselves are not very diversified (the Vanguard ETF holds 27 securities, with 87% of the fund's assets in the top 10 holdings). Market Vectors have recently introduced an ETF with capped individual holding weights which mitigates this issue, but only slightly.

Given the lack of diversification in the funds themselves it's hard to recommend them as a large proportion of an overall portfolio. A very small allocation seems reasonable if this segment appeals.
I use DFA Global Real Estate Trust to get around some of these issues. It's only about 27% domestic which helps bump up overall portfolio international allocation. 330 securities, with top 10 about 32% of total is good diversification. 0.42% isn't too bad a fee.
I personally put 20% of my equities into REIT's - I think they are different enough to be worthy of a good chunk of a portfolio, and they get a bonus weighting as protection against high inflation.
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daffyd
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Re: Diversification in practice: Investing from Australia

Post by daffyd »

Thanks for all the thoughts.

I completely agree [but perhaps did not say strongly enough] that in the first instance international equity diversification is the first and best port of call. However many struggle with home bias. I know I do – I struggle to have more than 50% of my equities outside Australia, although I’m trying to adjust closer to 60% international (and I know many in the US also struggle with this, although it is less of an “error” when your equity market is close to half the world’s). And I’d suspect my home bias is small compared to the average, certainly the allocations in people’s Super funds suggest that. I also seem to recall that Australia’s stock market is currently relatively highly correlated with emerging markets, Simplegift.

I’d guesstimate that franking is close to a 1% return advantage. Many of the larger firms do offer fully or partially-franked dividends (in particular the banks) so it ends up with the Vanguard Total Australian Stock Market fund/ETF (actually the top 300) 77-78% franked in recent years. So it is substantial enough to make a difference but not to justify the home bias we typically see in Self-Managed Superannuation Funds, likely the most "engaged" segment of the local retirement assets market.

in_reality, I’m not convinced any of the International Small Value-ish ETFs are quite there yet but I expect a significant holding in Vanguard’s VSS shortly.

Thanks for the kind words Tonen. I’m still in two minds about REITs. May I ask, do you use a full advisory service with DFA access or is it more a transactional relationship to access the funds?
Tonen
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Re: Diversification in practice: Investing from Australia

Post by Tonen »

I am fortunate to have just an "execute only" transaction service for DFA access.
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daffyd
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Re: Diversification in practice: Investing from Australia

Post by daffyd »

I found an interesting paper on value (index) investing that broke down results by country including Australia.
http://www.brandes.com/docs/default-sou ... omenon.pdf

It perhaps can help us understand Small Cap active management out-performance in Australia.
On page 24 of the paper is a chart of rolling 5-year average returns by value (P/B) decile (but keep in mind each decile is around 20 stocks).

While the value premium appears substantial and highest in the lowest Price-to-Book stocks, the majority of the premium is earned by avoiding the highest 10% of Price-to-Book stocks. That is, if a manager avoids the 10% "most expensive" stocks on a simple measure that would have been enough historically to outperform the Small Ordinaries index. Obviously this is in hindsight but perhaps can help explain the consistent outperformance of active small-cap funds in Australia over many years (even after fees and correcting for survivorship bias). The question is, who is buying these small "glamour" stocks?

In unrelated news I just set up a brokerage account. I found that Charles Schwab no longer take Australian residents (as new customers at least; I cannot provide insight for US citizens moving to Australia). I had hoped to use their commission-free ETFs to top-up core holdings when dividends come through.

Instead I was able to set up an account with optionsxpress.com.au (a Schwab subsidiary) who despite their name are fine for buying and holding ETFs (no custody fees, unlike some Australian brokers with International purchases). Brokerage is ~$15USD but they gave me 5 free trades for funding my account rapidly, enough for the first year or two: I'll only use products that I can't readily access from Australia such as my initial purchases of VIOV (Vanguard S&P Small-Cap 600 Value ETF) and VSS (Vanguard FTSE All-World ex-US Small-Cap ETF). So far it's fine; Live US data on less-liquid ETFs is a bit spooky as you can actually see the high-frequency traders at the margin and there's no market-depth data. The spread on depositing money in AUD into your USD brokerage account was remarkably reasonable at around 0.5-1c (but a strategy is needed for getting the money back into AUD as they will only wire USD and not to third parties such as currency exchange websites. Citibank look to be my preferred option if required but do some due-diligence before jumping in).
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Re: Diversification in practice: Investing from Australia

Post by Tonen »

Just be careful not to drop dead. US tax law apparently has some usurious death-duties on any aliens (=non-US citizen human beings) holding any US domiciled assets over $60k or so.
RhinoTroy
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Re: Diversification in practice: Investing from Australia

Post by RhinoTroy »

Small cap outperformance in the last few years has mostly been about the massive gap between resources and industrials performance.

Franking credits are worth about 1.5% a year to Australian taxpayers. Some/most of this is already priced into stock prices, based on dividend drop off studies. But none of the value of franking credits is priced into derivatives contracts.

Australian market is very concentrated in financials and in larger stocks so a portfolio which minimizes exposure to those Top 20 makes a lot of theoretical sense.

Offshore diversification looks like a good strategy given the high value of the exchange rate, and FX exposure tends to diversify equity volatility risk, with the following caveats:

* Australian market is more highly correlated with EM stocks through resources linkage than say 20 years ago
* AUD is also highly correlated
* valuation of US small cap stocks is unattractive, and biotech/tech stuff is eye-watering
* many parts of Europe look scary (e.g. Greece, Spain, Italy etc) but against historical valuations look very cheap
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daffyd
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Re: Diversification in practice: Investing from Australia

Post by daffyd »

Tonen wrote:Just be careful not to drop dead. US tax law apparently has some usurious death-duties on any aliens (=non-US citizen human beings) holding any US domiciled assets over $60k or so.
Thanks Tonen. Due to the US-Australia tax treaty it's a problem if your (global) estate is over around $1.5m (an indexed figure). I've got a while yet there.

Good point on the small caps, RhinoTroy. Resources have indeed underperformed over the past few years. The paper I linked to was based on more than 30 years of returns. I also agree international diversification is the correct move, particularly in the accumulation stage where currency effects are likely to average out over time.
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JamesG
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Re: Diversification in practice: Investing from Australia

Post by JamesG »

Thanks Daffyd, a very interesting post.

I hold the equity component of my portfolio in the proportion 60/40 foreign/Australian, both to diversify away from Australia in general, and also to avoid the heavy concentration in the Australian market in particular.

But now I confess to being alarmed by the last few contributions.

Is it really the case that an Australian resident is subject to U.S. estate taxes on the U.S. based assets they hold through their superannuation fund, or through Australian-based products offered by Vanguard and similar?
He who has a garden and a library wants for nothing. Cicero.
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in_reality
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Re: Diversification in practice: Investing from Australia

Post by in_reality »

JamesG wrote:
Is it really the case that an Australian resident is subject to U.S. estate taxes on the U.S. based assets they hold through their superannuation fund, or through Australian-based products offered by Vanguard and similar?
US based assets are taxable. Tax treaties give a credit against these taxes. Total global holding affects the US tax credit for taxes on assets in the US.

Think about it. Why should an Australian investing in the US get favorable tax treatment? They shouldn't.

If my estate is over the about $5M limit, I'll have used up the credit available to Americans. Why should a non-American with a non-US estate of say $500M, not be liable for estate tax in the US because their holdings there are only $3M?

The unified credit system that exist now came about in court to give the same deal as Americans get. We Americans would be paying tax on that $3M, so thats why the rule is what it is.

Not sure where the 1.5M figure is from... Maybe that is a previous level. It's over $5m now unless Australia deviates from the typical treaty.
555
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Re: Diversification in practice: Investing from Australia

Post by 555 »

RhinoTroy wrote:* AUD is also highly correlated
AUD is also highly correlated to what?
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daffyd
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Re: Diversification in practice: Investing from Australia

Post by daffyd »

JamesG wrote:
But now I confess to being alarmed by the last few contributions.

Is it really the case that an Australian resident is subject to U.S. estate taxes on the U.S. based assets they hold through their superannuation fund, or through Australian-based products offered by Vanguard and similar?
I'm not a tax expert but my understanding is that Australian domiciled funds are fine. This includes most superannuation options with international investments and vanguard's 'managed funds'. However iShares and vanguard's cross-listed ETFs such as VTS and VEU are impacted.

I'm having trouble finding a citation for the ~1.5m figure on my phone. It may well be higher (or might be the size of the tax credit rather than the estate). My main point was it's much larger than the $60,000 applicable to non-treaty country residents.
venger
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Re: Diversification in practice: Investing from Australia

Post by venger »

Hi Daffyd,

Thanks for your original post - I thoroughly enjoyed it. It provided a good overview of the existing ETF options and your discussion regarding home bias and lack of small/value passive index options for the Australian investor is very close to my heart :)

One question though - your post didn't really consider the Vanguard Australia LifeStrategy funds. Their premix funds cater for several risk levels - all the way to High Growth which is 90% equities and 10% fixed interest. The equities are 50/50 ASX/international. There is some REITs in there (ASX & international), also small caps and emerging markets. No value tilt, though.

All-in-all a simple option for the set-and-forget. Fees are a bit high for the retail account, but they do step down to 0.35% once the total > $100k. Would seem to be pretty competitive when you compare it against the ETFs options/brokerage/rebalancing costs - no?
hd123
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Re: Diversification in practice: Investing from Australia

Post by hd123 »

Good write-up daffyd - I think the other factor for home bias with Australian investors is the relatively high dividend yield that most top industrial shares pay.
daffyd wrote:I'm having trouble finding a citation for the ~1.5m figure on my phone. It may well be higher (or might be the size of the tax credit rather than the estate). My main point was it's much larger than the $60,000 applicable to non-treaty country residents.
From what I can tell it's the size of the tax credit, which is now just over $2m for 2014 estates under the US-Australia tax treaty. The credit is applied on a pro-rata basis, based on the amount of US-based assets versus the total portfolio.

iShares mention in their cross-listed ETF information that "depending on the structure/vehicle that owns the US situated assets, estate tax may not apply". I haven't had it confirmed (the knowledge level here is low!) but I would guess an SMSF with a corporate trustee may be one of those structures.
venger wrote:All-in-all a simple option for the set-and-forget. Fees are a bit high for the retail account, but they do step down to 0.35% once the total > $100k. Would seem to be pretty competitive when you compare it against the ETFs options/brokerage/rebalancing costs - no?
My problem with these is that the asset mix doesn't change over time like a target retirement date fund would (which Vanguard Australia don't offer). A 90% growth/10% income fund would suit a 30 year old but not so much a 70 year old in retirement. You would need some degree of rebalancing as you got older, so you may as well get hands on and purchase/rebalance your ETFs and funds yourself. I guess you could use a combination of the High Growth fund with an increasing level of fixed interest over time but I prefer the flexibility of having each asset in a separate fund/ETF.
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Re: Diversification in practice: Investing from Australia

Post by venger »

I was also thinking about the ETFs listed in the 1st post - would it be possible to use these to put together a portfolio with some value & small tilts?
e.g. 5-fund ETF portfolio
20% S&P World ex Australia (WXOZ) - MER 0.42% with 1500+ stocks
20% S&P Global Dividend (WDIV) - MER 0.50% with 100 stocks
20% S&P Emerging Markets (WEMG) - MER 0.65% with 900+ stocks
20% iShares S&P/ASX Dividend Opportunities Fund ETF (IHD) - 0.30% with 50 stocks
20% Vanguard MSCI Australian Small Companies Index (VSO) - 0.30% with 150+ stocks

Pros
- Higher yield, possibly valuey
- Different geographics, stocks in the funds should not overlap
- Small/mid caps, emerging markets
- IHD has limits on sector (20%) and individual stock (4%) so even though is only 50 stocks, it is less concentrated than ASX300 index
- S&P (Street State Global) ETFs used, these are not US-domiciled it seems, so no US-forms required etc

Cons
- Only 2000+ stocks
- High turnover? capital gains risk?
- Higher MER than simply holding ASX300 (~0.25%) and S&P World (0.42%)
- 60% of portfolio concentrated in only 300 stocks
- Emerging markets possibly not required, ASX300 highly correlated with EM?

Suggest away...

PS: Obviously the above 'portfolio' is focused on the equities portion only. Bonds portion would then be used to dial up or reduce the risk levels as required.
Last edited by venger on Tue Sep 09, 2014 8:59 am, edited 1 time in total.
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Re: Diversification in practice: Investing from Australia

Post by AlohaJoe »

venger wrote: All-in-all a simple option for the set-and-forget. Fees are a bit high for the retail account, but they do step down to 0.35% once the total > $100k. Would seem to be pretty competitive when you compare it against the ETFs options/brokerage/rebalancing costs - no?
The fees don't step down, exactly. You pay a different rate on the marginal balance above $100,000. So if you have $50,000 in assets you're paying 0.9%. If you have $100,000 you're paying 0.75%. If you have $150,000 you're paying 0.61%. If you have $500,000 you're paying 0.41%. Compared to the 0.20% or so on ETFs that's quite a lot.
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Re: Diversification in practice: Investing from Australia

Post by venger »

AlohaJoe,

Agree with the math. But as you said, for larger portfolios, its total MER is closer to 0.41% which isn't too bad - relative to the international ETFs. And it has all the facilities, e.g. electronic fund transfer, auto-balancing included.

International ETFs typical MERs are > 0.5%, and fees go up for those in small cap/EM space. The Vanguard international ETFs are an exception being very cheap, but they are also domiciled in US so create their own administrative issues I think (must admit have not used these before).
Not to mention that rebalancing/purchase of ETFs over time will incur brokerage costs.

Not knocking ETFs - as I like that they are at least now an option for us; but just noting that the LifeStrategy funds still seem a pretty competitive option - this surprised me...

Appreciate your comment...
Last edited by venger on Tue Sep 09, 2014 11:58 pm, edited 2 times in total.
555
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Re: Diversification in practice: Investing from Australia

Post by 555 »

555 wrote:
RhinoTroy wrote:* AUD is also highly correlated
AUD is also highly correlated to what?
Anyone know what was meant here?
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jackpistachio
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Re: Diversification in practice: Investing from Australia

Post by jackpistachio »

555 wrote:
555 wrote:
RhinoTroy wrote:* AUD is also highly correlated
AUD is also highly correlated to what?
Anyone know what was meant here?
AUD is highly correlated to EM demand for resource exports from Australia (mining & energy being two big ones), so taking a chance to speak for RhinoTroy I think its a continuation of his first bullet:

* Australian market is more highly correlated with EM stocks through resources linkage than say 20 years ago
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daffyd
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Re: Diversification in practice: Investing from Australia

Post by daffyd »

venger wrote:I was also thinking about the ETFs listed in the 1st post - would it be possible to use these to put together a portfolio with some value & small tilts?
e.g. 5-fund ETF portfolio
20% S&P World ex Australia (WXOZ) - MER 0.42% with 1500+ stocks
20% S&P Global Dividend (WDIV) - MER 0.50% with 100 stocks
20% S&P Emerging Markets (WEMG) - MER 0.65% with 900+ stocks
20% iShares S&P/ASX Dividend Opportunities Fund ETF (IHD) - 0.30% with 50 stocks
20% Vanguard MSCI Australian Small Companies Index (VSO) - 0.30% with 150+ stocks
A couple of comments:
It was recently pointed out to me that WXOZ only samples its index. It actually holds only 350ish stocks (e.g. Exxon but not Chevron).
IHD I really liked the idea of too but now have some concerns about turnover and capital gains being distributed.
The reach for yield at present means I'm not sure dividend funds are generically all that valu-ey.

To be honest (assuming well below estate tax limits), we can probably get enough international diversification from just VTS and VEU (perhaps supplemented by Super). I've only recently just reached a balance where tilting could be done in a cost-effective manner but opened a US-based brokerage account to access the size and value factors more efficiently.

I really wish I could be comfortable with the investable broad Small Cap indices in Australia. Unfortunately they've been consistently outperformed by active funds, perhaps for some of the reasons we've discussed above, perhaps just being front-run. Here's hoping someone opens a RAFI ETF with better pricing than the Colonial Wholesale product (even then, I'd be concerned about turnover outside Super but might bite the bullet anyway).
ausinv3st
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Re: Diversification in practice: Investing from Australia

Post by ausinv3st »

Hi everyone,

I found this thread while looking for small cap value ETF (US and international) available to Australian investors.

The most attractive offering that I found was Vanguard MSCI World Ex-Australia, but it not tilted to value.
Have any new / better ETFs become available since this thread was last updates (2014)?

Thanks
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Re: Diversification in practice: Investing from Australia

Post by LadyGeek »

ausinv3st, Welcome!

While I don't have the expertise to answer your question, we have a wiki article that may helpful: Investing in Australia

(The wiki article was created in 2016, but is in need of an update. If anyone has suggestions, please post here or in Suggestions for the Wiki.)
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
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BeBH65
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Re: Diversification in practice: Investing from Australia

Post by BeBH65 »

Hi ausinvest,
ausinv3st wrote: I found this thread while looking for small cap value ETF (US and international) available to Australian investors.

The most attractive offering that I found was Vanguard MSCI World Ex-Australia, but it not tilted to value.
Have any new / better ETFs become available since this thread was last updates (2014)?
Good value and small cap funds are difficult to find for non us- based investors. There have been a few threads in the forum recently.
You might want to look at Vanguard Global Value Factor UCITS ETF - ISIN IE00BYYR0B57, Tick Vval. It does do value, a large chunk in small cap and although it is an active fund it doe have a low ER. Ishares also has a value Etf I his edge series.

Regards,
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence). | Have a look at https://www.bogleheads.org/wiki/Outline_of_Non-US_domiciles
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daffyd
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Re: Diversification in practice: Investing from Australia

Post by daffyd »

ausinv3st wrote:Hi everyone,

I found this thread while looking for small cap value ETF (US and international) available to Australian investors.

The most attractive offering that I found was Vanguard MSCI World Ex-Australia, but it not tilted to value.
Have any new / better ETFs become available since this thread was last updates (2014)?

Thanks
The only reasonably priced Australian domiciled fund I know of is the Australian version of Vanguard global value (wholesale, but they'll let you invest with $100,000 minimum if you call them). Still more expensive than US or UCITS ETFs.

What I've done is use US domiciled ETFs to get closer to the factor exposure I seek. There are a variety of ways to access them. I use optionsXpress which recently followed their owner Charles Schwab in offering $5usd trades. Interactive Brokers is cheaper if you trade frequently. Some of the Australian brokers aren't as bad as they used to be for reasonably small amounts as long as you transact at least once per year.

I use the same sort of funds for my non-Aus exposure as many of our US colleagues​ - Vanguard small cap value (US only - VBR, although starting from scratch I would think again about IJS if living in Australia or the US), International ex us small cap (VSS) and an international value ETF (I use an expensive, more heavily factor exposed one but would probably use Schwab's FNDF at only 0.25% p.a. if starting from scratch).

I'm comfortable with the US-Australia tax treaty but I'd suggest you get advice or your own comfort around its implications and risk of changes as I'm not a tax expert. If there's any likelihood you'll reside in a country without a good US tax treaty in the future I would probably not use US domiciled funds.

Re: UCITS ETF mentioned above, I have no idea how they work for tax purposes in Australia. If there was a distributing version (that passes through dividends) in theory I'd think you just pay regular taxes on international income but with an 'accumulating' fund you'd still be liable to pay taxes but I don't know if you'd get reliable information on the accumulated income you should be paying taxes on.
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Re: Diversification in practice: Investing from Australia

Post by Ma15 »

daffyd wrote:
ausinv3st wrote:Hi everyone,

I found this thread while looking for small cap value ETF (US and international) available to Australian investors.

The most attractive offering that I found was Vanguard MSCI World Ex-Australia, but it not tilted to value.
Have any new / better ETFs become available since this thread was last updates (2014)?

Thanks
The only reasonably priced Australian domiciled fund I know of is the Australian version of Vanguard global value (wholesale, but they'll let you invest with $100,000 minimum if you call them). Still more expensive than US or UCITS ETFs.

What I've done is use US domiciled ETFs to get closer to the factor exposure I seek. There are a variety of ways to access them. I use optionsXpress which recently followed their owner Charles Schwab in offering $5usd trades. Interactive Brokers is cheaper if you trade frequently. Some of the Australian brokers aren't as bad as they used to be for reasonably small amounts as long as you transact at least once per year.

I use the same sort of funds for my non-Aus exposure as many of our US colleagues​ - Vanguard small cap value (US only - VBR, although starting from scratch I would think again about IJS if living in Australia or the US), International ex us small cap (VSS) and an international value ETF (I use an expensive, more heavily factor exposed one but would probably use Schwab's FNDF at only 0.25% p.a. if starting from scratch).

I'm comfortable with the US-Australia tax treaty but I'd suggest you get advice or your own comfort around its implications and risk of changes as I'm not a tax expert. If there's any likelihood you'll reside in a country without a good US tax treaty in the future I would probably not use US domiciled funds.

Re: UCITS ETF mentioned above, I have no idea how they work for tax purposes in Australia. If there was a distributing version (that passes through dividends) in theory I'd think you just pay regular taxes on international income but with an 'accumulating' fund you'd still be liable to pay taxes but I don't know if you'd get reliable information on the accumulated income you should be paying taxes on.
Are you holding US domicile assets in your personal name? We have a tax treaty with the US but we'd still be faced with estate tax issues above the $60,000 regardless unless they're held held through a corporate trustee.
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Re: Diversification in practice: Investing from Australia

Post by TedSwippet »

Ma15 wrote:Are you holding US domicile assets in your personal name? We have a tax treaty with the US but we'd still be faced with estate tax issues above the $60,000 regardless unless they're held held through a corporate trustee.
Australia is one of just a handful of countries with an estate tax treaty with the US. It is listed as 'pro-rata unified credit', which generally means that Australians get the same exemption as US citizens based on the ratio of property in the U.S. over the gross worldwide estate. Consult the actual estate treaty text to be certain.

In other words, there should be no US estate tax danger provided your aggregate net worth is below 5.49mm USD (2017 figure). Just a potential heap of IRS paperwork to get the estate released.
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