The Australian market is highly concentrated with a large representation in the financial services and resource sectors. The top 10 Australian companies make up around 50 per cent of S&P/ASX 300 Index, with four out of the top five companies in the financials sector.

Many industries are not represented or under-represented in Australia. For example, the MSCI World Index has an allocation of more than 25 per cent to the fast-growing information technology and healthcare sectors. By comparison, Australia has less than eight per cent in these sectors.

As such, investing internationally may increase your diversification and give access to industries and companies not available in Australia. After all, Australia represents around two per cent of the total world sharemarket.

Improving your risk/return profile

Diversifying your portfolio internationally may help to improve your return potential and potentially lower your risk.

As each country experiences different economic growth rates, consumer sentiment and political issues, international sharemarkets may grow at different rates. Within each country there will also be industries and companies that perform better at different times. For example, the retail sector tends to perform well when interest rates are low and consumer confidence is high.

Accessing global investment opportunities

Investing in a global equity fund that tracks the MSCI World Index is one way of achieving access to many of the world's best known brands.

There are a number of different international share fund types, including:

Country or regional funds invest in a single country, like the US, or a single region like South-East Asia.
Global share funds hold a diversified portfolio across world sharemarkets.
Specialist funds like global sector-, theme- or style- biased funds can invest in a single sector like global resources or a basket of countries like emerging markets, for example.
Index funds are designed to track a market index so they will hold a wide variety of stocks. Index funds are also available in global, country and sector types.

Risk/return characteristics

Shares are generally considered a high-risk and high-return investment and are suitable for longer-term investors.

Historically, international shares have provided long-term growth well above inflation. However, shorter-term sharemarket returns have experienced higher volatility at times.

Sharemarket investors may expect a negative return approximately once in every five years or so, which is why shares are suited to longer term investors. Time greatly reduces, but does not eliminate, the volatility in returns from shares.

Sharemarkets move in cycles, reflecting the underlying strength of the economy, political factors, industry trends and market sentiment. On any given day interest rate and inflation expectations, company profits, dividends, economic growth figures and the rise or fall of our dollar may have an impact on share prices.

Currency

International share portfolios receive their returns from two sources - the change in the value of the investment and currency returns. When the Australian dollar rises relative to overseas currencies, it has a negative performance impact for Australian investors, and vice versa.

Fully hedged funds incorporate a currency hedge to act as a buffer against local currency fluctuations. In effect, the total return is relatively unaffected by currency fluctuations, however the hedging can affect income distributions. When the Australian dollar appreciates, distributions may be higher, but a depreciating dollar can result in low or nil distributions. As the Australian dollar exchange impact has been removed, hedged investors may focus solely on international market movements.

Having said that, investors can face an opportunity cost to currency hedging. Currency exposure may add an important diversification element to overseas investing. While US dollar denominated assets may make up the largest component of an international equity portfolio, a diversified international portfolio may be exposed to more than 12 different currencies.

Some fund managers will partially hedge their portfolios based on their market outlook. Currency markets can be volatile and speculation on currency movements risky.

Vanguard Australia