Why More Malaysians Should Diversify Their Investments Overseas

Lately the ringgit has come under scrutiny for breaching the RM4.80 mark against the US dollar for the second time in 5 months. However, currency is only one factor which is part of a wider issue that Malaysians should look abroad to diversify their investments. While Malaysians may feel disadvantaged given the lag between news flow, we are more connected than even before. Investing broadly through an index would diversify away negative news flow toward to a single stock.

Investing overseas, like anything else, comes with risk. There have been instances of sectors abroad that have undergone turmoil such as the US Banks during the global financial crisis, the Chinese tech sector in 2021 and the Chinese real estate downturn in 2022. To mitigate these risks, most investors should diversify across different geographies, sectors, and industries. 

Malaysians have too much of their assets invested in Malaysia

Firstly, real estate is a uniquely local asset class. Collectively, Malaysians’ homeowners hold RM2.3 trillion worth of real estate according to EdgeProp. For most people, their primary residence makes up a significant portion of one’s wealth. Next up, looking at Malaysians’ cash holdings, Bank Negara statistics show that individual Malaysians hold RM800 billion in cash. Only RM22 billion worth, or 2.7%, held in foreign currencies on-shore, presumably by high net worth individuals.

Next, we look at our local stock market, of which, retail participation makes up around 20%, or RM371 billion in equity holdings. Bursa Malaysia lists predominantly Malaysian companies, as less than 10 of the approximately 800 listed companies are incorporated overseas. While there are large regional champions that some overseas presence, the exposure gained when investors buy Malaysian equities is almost purely local. By contrast, the New York Stock Exchange lists 530 of largest international companies from 45 countries.

Malaysian’s fund management scene is where there is some overseas exposure. Of the RM975 billion in assets under management, 42% are invested in foreign markets. Fund managers have built expertise to include foreign holdings which can play to their advantage when certain markets heat up. In the past two decades several geographic themes have come up including China, India, and the US. However, most of these unit trusts are hedged and the currency risk neutralised, which is a disadvantage since many currencies have strengthened against the ringgit.

Finally, two commonly held assets are EPF savings and investments in Amanah Saham Bumiputera (ASB). These professionally managed funds have 37% and 19% foreign exposure respectively, which has gradually been increased to get better risk-adjusted performance. As the risk of these funds are balanced to cater for investing objectives like long term wealth accumulation and retirement, the strategic asset allocation needs to be diversified. Malaysians could emulate these institutional investors to diversify overseas and enjoy enhanced returns. The EPF for example, reported that for the first three quarters of 2023, 37% of the portfolio was invested overseas. That foreign exposure contributed 45% of the investment income. How much to invest abroad differs depending on one’s risk tolerance. Leading asset managers suggest anywhere between 20% to 40% of one’s wealth, invested overseas to enjoy the full benefits of diversification.

Better Risk Reward

Foreign markets not only provide better overall returns, but also risk-adjusted returns. While US indices like the S&P 500 and Nasdaq have provided stellar returns over the past decade by posting 12.5% and 17.8% p.a. respectively, they also have superior Sharpe Ratios. This ratio measures the portfolio’s efficiency in generating those returns. For every unit of risk these two markets post higher returns compared to other regional markets.

Other regional exposure to consider would be European, Japanese and broader Asian equities. These markets have posted 3.3% to 5.3% p.a. over the past ten years. Compared to the local market, which has decreased overall by -1.6% p.a. in the same period, these are better alternatives. Granted that the local market may be better for stock picking, investing internationally to get global exposure does not require an investor to be a stock picking expert and passive exposure is enough to get you superior returns.

Diversification

An additional benefit to diversifying globally is access to different sectors and industries. These different sectors can also perform differently depending on the economic cycle. So having a mix of defensive and cyclical companies in your portfolio helps with reducing your overall risk. Much has been said about the magnificent seven tech stocks that drove the US markets last year, so let us examine the top holdings of other markets.

European markets are known for mature companies operating in the healthcare and consumer staples space which provide stable dividend income streams. Asian markets are a proxy to the fast growth of China and India. While China is in a slump, the long-term prospects as the world’s second largest economy cannot be ignored. India’s stock market has also recently reached the $4 trillion market cap milestone due to its impressive economic growth and demographics.

To build wealth, Malaysians need to diversify their currency holdings

One could also hold foreign currencies, while getting returns through multi-currency fixed deposits or low-risk foreign treasuries. Holding US dollars over the past ten years would have seen a 45% FX appreciation, on top of the 5+% yields that have emerged from the Fed’s rate hikes. The ringgit is trading within the 4.7 to 4.8 range against the US dollar, which is at an all-time high. Even so, the ringgit has reached new all-time highs 69 times since it was de-pegged in 2005. To diversify timing risks through unfavourable FX entry points, like any other long term investment, investors should dollar cost average and hold for a long period of time.