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International shares – which ones are outperforming?

In my humble opinion, allocating some of your funds to invest in international shares is a good idea for any SMSF. Most large super funds do offer exposure to international shares but most SMSFs prefer to hold Australian shares only. One of the favourite investments for SMSFs are “blue chip” Australian shares but when you look at the largest companies listed on the ASX, they are mainly resource and financial companies. There are no major technology companies listed on the ASX, yet information technology and biotechnology are some of the fastest growing industries in the world. One good reason for investing in international shares is simply to get some exposure to growth sectors which are not available on the ASX. Buying international shares is quite simple and you can buy them through popular online brokers like CommSec. The brokerage fees are higher for international shares and if you do not like to pay high fees, international discount brokers like Interactive Brokers charge as little as $1 to buy 100 shares of companies that are listed on US stock exchanges. If buying direct shares is too troublesome, a simple way to get exposure to international shares is to buy International Exchange Traded Funds (ETFs) which are listed on the ASX. Buying these are as simple as buying any Australian listed shares. A list of available International ETFs can be found on the ASX website.

The current list of international ETFs include ETFs for China and the US. If you have a choice of buying an international ETF for China or the US, which one would you buy? I would bet that most people would choose China, right? Everyday we hear positive news about China’s economy and everyone is looking at China to lead the global recovery. The US economy on the other hand is struggling with high unemployment, home foreclosures and skyrocketing government debt. However, when we look at the performance of the Chinese ETF (IZZ.AX) vs US ETF (IVV.AX) in the past six months, we get quite a different picture as shown in the chart below.

The US ETF is far outperforming the Chinese one in 2010. In the past few months, US stocks have been doing surprisingly well. Most of the major US stock indices made new 17 month highs in March 2010. The bad US economy and good Asian economies have been very good for large US companies who sell their products globally. The US ETF IVV.AX comprises of large cap stocks like Apple, IBM, HP, McDonalds, Kraft foods, etc. These companies sell their products globally and the recovering Asian economies have helped to boost their sales. Other large companies like Best Buy and Goldman Sachs have benefited because their major competitors went out of business. Walmart and Amazon and other discount retailers have grabbed market share from smaller retailers. With high unemployment and low inflation, their employees are prepared to work hard without expecting higher wages. Interest rates are also at record low levels and all these factors help to keep the costs low for these companies.

Large Chinese companies who mainly make money from exports on the other hand are struggling. Their main customers who are from the US and Europe are buying less. Recently, Chinese Commerce Minister Chen Deming said that China could report a trade deficit in March 2010. To keep sales up, prices have to stay low, putting a squeeze on profit margins. The Vice Commerce Minister Zhong Shan said that the profit margin on many Chinese export goods was less than 2%. Rising inflation and interest rates will also increase costs and put further pressure on margins.

I have noticed that the Shanghai Composite Index has been lagging other global stock indices since August 2009. Many analysts attributed it to the credit tightening by the Chinese government, which undoubtedly had some impact. With the recent revelations by the Chinese Commerce ministers, perhaps another reason for the poor performance could simply be that many of the companies are not as profitable and this is being reflected in their share prices.

In summary, the best way to take advantage of a China led recovery may not necessarily be by investing in a China Fund. Investing in world class companies (international “blue chips”) who sell a lot of their products to China may be a better way to go.

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