Comment: Why global diversification is good

The recent rate rise should slow the economy, as it is designed to do. Debt is going to cost more and make repayments on mortgages and other consumer finance dearer. The high dollar means exporters will be earning less and New Zealand as a tourism destination becomes less attractive.

Obviously, this will affect the New Zealand equity market as profits adjust to the new economic environment but what scares some people and is often not commented on much, is the impact on the finance companies which remain an integral part of the New Zealand economy.

I do not believe, in general terms, that finance companies are bad investments, or are badly managed other than one rider: there are some that are better than others.

The changed outlook for the New Zealand economy from interest rate rises will definitely impact finance companies. The single most important question is whether their balance sheets are strong enough to cope with the weaker economic conditions and what effect a higher unemployment rate, for example, would have.

The answer is not an easy one and really depends on which finance companies an investor may have exposure to and, furthermore, which type of security they have (secured debt securities being less risky than unsecured ones).

I am, however, sure of two things. Firstly, that many finance companies with good management and strong balance sheets will be just fine while others may find themselves in some strife depending on how the economy reacts to the economic conditions over the next few years.

Secondly, there are many other regions of the world that are at a different point in the economic cycle to New Zealand. Therein is the answer for investors. If other markets provide better opportunities for capturing return with arguably lower risk (because they are not in the same economic position as New Zealand), why would investors not access those opportunities?

These markets and opportunities are not readily accessible to the average investor. Sure, there are managed funds, but how diversified are they and do they have currency risk? They can rise and fall over time, so what if one selects a fund with exposure only to one overseas economy?

Maybe if there was a way to invest away from the New Zealand economy for a portion of an investor’s portfolio that was also easy to access, investors would see it as a credible strategy to diversify their risk.

In fact, as the New Zealand Institute recently pointed out in their latest discussion paper, ‘No Country is an Island’. The investment community stands to benefit enormously from a greater engagement with global economies.

There are some products available to New Zealand investors that reflect their changing needs and address the issue of overseas diversification. Many have also taken the time to understand New Zealand investors and have drawn some conclusions about what they want and need.

New Zealand investors tend to be highly sophisticated and it is apparent that a debt security which provides access to mostly credit investments across several economies, large ones and smaller ones, with all currency risk hedged to the New Zealand dollar would fit today’s needs.

Investors also want protection against uncertain times through diversification and capital protection. The portfolio should be managed by several, instead of one, specialist managers and investors’ capital should be protected by a global financial institution. Naturally investors also want better than average returns. A way of exiting the product before maturity in case you need to access your cash is also wanted. Most of all they want a manager that is prepared genuinely to align with their investors.

Recent experience has served to demonstrate that, in line with this research, New Zealand’s investors are indeed aware of the benefits of global diversification but that they are being cautions about the way they approach it. Ultimately there is a growing market for investing outside of New Zealand but only with the security created by diversification, capital protection from a global institution and evidence that the manager’s interests are totally aligned with the investors.

Regardless of current market conditions, apparently the sophisticated and innovative investors who have always helped New Zealand’s economy punch above its weight are alive and kicking. Far from running for cover as some commentators have suggested many people are treating this situation as a reason to look to new opportunities. As ever, New Zealand’s investors are protecting their investments and then going where the returns are.

Deon Joubert is the managing director of Absolute Capital Group Limited.

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