Diversification across markets, asset classes and currencies is one of the basic tenets of investing. Those who follow this strategy religiously would likely have seen their investment portfolios perform better than those who remained entrenched in the local market.
What used to be considered fairly robust returns – such as ASB dividends of 8% per annum and EPF dividends of 6.5% per annum – now seem menial if you take into account the 30% drop in the value of our ringgit.
It is no surprise then that by now, many Malaysians have accepted the fact that the ringgit may not bounce back to RM3.20 to US$1 anytime soon, and that it is time to diversify their assets by means of foreign investments.
This is good. But before putting your money into foreign investments, you need to know what you are getting yourself into, and carefully consider your decisions before making your moves.
Firstly, how much of your investable assets should you allocate to foreign investments?
The rule of thumb is to allocate not more than 30% of your investable assets into foreign currency investments. The reason for this is that your daily life still revolves around the Malaysian currency, and your foreign investment is merely a means of bolstering your net worth.
Besides, if the US currency weakens, you run the risk of losing a significant amount of money if your primary invested assets were in US dollars. In recent months, anyone who bought into the pessimistic view out of fear that the ringgit would touch RM5 to US$1 would have seen the value of their foreign investment shrink owing to the strengthening of the Malaysian currency. Therefore, putting more than 30% of investable assets into foreign investments would be over-investing, not to mention highly risky.
The second point to consider is, how do foreign investment markets fare in comparison to Malaysia?
If you have not had any experience investing overseas, you may be in for a big surprise. Many Malaysians assume that the investment market overseas works more or less the same way as it does locally. However, this is not the case.
Unlike Malaysia, foreign investment markets such as US, Singapore and Hong Kong are far more open and have fewer regulatory restrictions. There’s also less government support for their market. As such, while these markets enjoy higher levels of global portfolio fund flows, they also experience higher levels of volatility and price fluctuations.
Let us take the example of bonds. In Malaysia, bond investments behave almost like a fixed deposit type of investment – steadily up and predictable (partly due to the accreting value of bond coupons recognised by the fund over time). However, the same can’t be said in other countries.
In the graph, you can see that a Malaysian bond fund (Fund A) moved up steadily over the period of comparison whereas the US (Fund B) and European (Fund C) bond funds experienced higher levels of price volatility and underperformed Fund A. All three funds invest in somewhat similar investment grade papers, only that they invest in different markets. This is mind-blowing for most Malaysian investors.
In fact, I had a client who once lost up to 20% of his investment in an Asian bond fund domiciled in Singapore. What made him very upset was that he wasn’t properly advised by the banker of the risk exposure of such a fund. Had he done a little more due diligence or consulted an independent financial advisor before investing into the fund, he would not have been caught off-guard and suffered such a significant loss.
The same applies to equity investment overseas. Many investors would have a hard time trying to adapt to markets that are more volatile than our FTSE Bursa Malaysia KL Composite Index.
The next point to consider is this: How safe is your capital when investing in foreign products? If things are not going well, will you be able to retain your capital at the least?
Let me highlight the example of an offshore commodity product that I once came across. This product focused on physical trading of commodities like timber, metals, aquaculture, rice, plant-based oil, crude oil and biofuel. It supposedly had an attractive track record, yielding double-digit annualised returns for more than two years since its inception. It targets to provide investors with a fixed 2.25% quarterly distribution (i.e. a total of 9% per year).
One of the most common mistakes made by Malaysian investors, however, is the tendency to look at foreign investments through the lenses of their local perspective and experience. At first glance, you might think this investment is no different than any other equity unit trust funds available in Malaysia – a credible alternative investment with good diversification credentials worthy of consideration.
However, the product turned out to be a scam and the investors lost all their money. This is not an isolated case. Due to their limited knowledge and experience, many Malaysian investors fail to differentiate genuine investments from scams. That costs them a lot of money.
Thus when investing in foreign markets, it is always better to stick to licensed and reputable fund managers that invest in regulated investments and markets. Lastly, before putting your money into foreign investments, you should thoroughly assess your cashflow needs in order to maximise the holding power of your investments.
A good cash flow management practice is to establish one’s ideal cash reserve before dabbling in investments. For working adults, this emergency fund should be able to cover six months of one’s cash flow needs such as living expenses, loan repayments and any other lump sum cash requirements over the next three years. I recall an incident where a client of mine underestimated the amount of cash he would need to execute his plans of building a bungalow on a plot of land he owned.
Only midway through the construction process did he realise that he was short of cash, after having invested the remainder of his liquid assets in foreign investments. In the end, in order to complete his dream home, he was forced to withdraw his foreign investments at a loss.
A situation like this could have been easily avoided with a little bit more cash flow planning and foresight. Make the necessary provisions for your short-term cash flow needs and you will position yourself to better withstand any unexpected investment market volatility.
Diversification of investments across markets, asset classes and currencies is a recommended risk management strategy for any investor and should be diligently pursued. However, never assume that investing overseas is similar to investing in Petaling Jaya. In the case of Malaysia’s relatively stable investment environment, entering into foreign investment markets could be akin to stepping into rough sea from a calm bay – it might come as a shock if you are unprepared.
Conduct your research thoroughly – find out more about the investing environment, the country’s regulations, and study the investment product carefully. Consult a professional if required, such as an independent financial advisor, to address any concerns you may have. Once you’ve considered the above and decided to invest, make sure that you monitor the performance of your investment closely.
The more volatile a market, the faster you’ll need to take action on your profits or losses. Park your profits somewhere safe to prevent losing it to the fluctuating market.If your investment is making a loss, then act fast with a contingency plan at hand.
Remember, the more prepared you are, the more likely you are to succeed. All the best!
Yap Ming Hui (firstname.lastname@example.org) is a bestselling author, TV personality, columnist and coach on money optimisation. He heads Whitman Independent Advisors, a licensed independent financial advisory firm. For more information, please visit his website at www.whitman.com.my