Discuss The Pros And Cons Of New Zealand Investors Choosing To Invest Off-Shore In Today'S Environment.

Introduction:

Information from the newspaper The Press shows that the growth of the New Zealand market is expected to drop to 1.9% and with low growth comes higher risk as companies struggle with low demand and low investment.

With the New Zealand economy slowing down New Zealand investors are looking to invest overseas to maximise returns on investments

This essay will discuss the pros and cons of New Zealand investors choosing to invest off-shore.

To do this, we will analyse four aspects affecting offshore investment from the individual's point of view comparing the NZ environment with the overseas environment and discuss how each is likely to change in the future.

These include currency risk, taxation, diversification and market volatility.

It is important to remember that the future speculation of each characteristic is not 100% accurate and is largely based on what has happened in the past.

Currency/Exchange Rate Risk

Recently the NZD has decreased in value especially against the USD and future outlook shows that it is expected to depreciate further. This is favourable for NZ investors that have funds invested overseas.

Currency risk is the risk of the NZD appreciating or depreciating in relation to other currencies, thus changing the value of the investment in NZD terms.

Economists predict that the exchange rate will continue to drop below 0.55 USD. Six months ago the NZD was trading at 0.6978 US and 80.03 Yen (www.rbnz.govt.nz) compared with 0.62 $US now and 73 Yen (www.au.yahoo/finance).

Putting other returns aside, a ten percent drop in the $NZ will increase the value of the investment by ten percent when sold.

NZ investors in general will be predicting the NZ dollar will decrease further and further and so are investing offshore into such markets as the US. This is because greater returns can be made buying offshore and then selling when the NZD is worth less.

Taxation

Tax has a negative effect on investment because it decreases yields. Double taxation is experienced overseas whereas in New Zealand, profits are only taxed once (i.e. company tax) (www.chapmantripp.co.nz).

Example:

A company has $10,000 profit, of which it pays $3,300 (33%) in tax to the government. New Zealand investors at this stage can receive the full $6700 in dividends, however, as an offshore company; investors would be taxed again through income tax thus receiving only $4489. This is known as double taxation.

Currently, in New Zealand the policy in place to stop investors getting taxed twice involves imputation credits which represent a portion of the tax already paid on the company's profits.

Overseas companies pay tax on profits and then investors have to pay tax on dividends.

At the moment, investing in the "grey list" means that investment can be taxed more favourable than investing in New Zealand or other countries (www.taxpolicy.ird.govt.nz).

Cullen plans to introduce new laws to extinguish "grey list". This will increase tax on overseas investors, discouraging offshore investment whilst encouraging domestic investment (www.taxpolicy.ird.govt.nz).

Diversification

Diversification offshore opens greater opportunities and variability of the markets and industries for a New Zealand investor. NZ market has limited investment opportunities because NZ is a small nation compared with overseas markets which are virtually endless.

For instance, the S&P500 US Index that has capitalisation of $USD 11.7trillion, S&P Europe 350 Ђ6.021 trillion, and S&P Japan500 Ґ351.3 trillion compared with NZSX50 which has capitalisation of $NZ 32.37 billion (www.standardandpoors.com, www.nzx.com).

Overseas markets offer more variation in industries including those that cannot be invested in New Zealand, e.g. the oil industry Shell Company and BP.

The oil prices have been rising, this could be a great opportunity for domestic investors to have some weights of their portfolio in oil assets.

On the 25th March 2005 North Sea Oil price was $US 54.25 per barrel compared with a year later price $US 63.15 per barrel on the 23rd March 2006 (The Times, p21, p51).

In addition by diversifying investors can reduce the unique risks, associated with individual assets, by creating a portfolio of assets. The idea is that the investors are trying to invest in assets that are negatively correlated or have very small correlation coefficients to offset the overall risk on the portfolio (Bodie, Kane,& Marcus, p915-923)

Example:

UK/Japanese correlation is 0.384 and Australian/Japanese correlation is 0.375 both of which can be considered small (www.commerce.otago.ac.nz).

In today's environment, the domestic economy is slowing down and it is predicted that the NZ market will reduce to a 1.9% p.a. growth by 2007, whereas overseas markets are predicted to outperform NZ markets significantly (The Press, Business Day, C2).

Therefore, it will be most beneficial for a NZ investor to invest into overseas assets.

Volatility of International Markets

The volatility of international markets greatly affects the risk that New Zealand investors face overseas.

As explained by Bodie et al., (2005, p. 914) the volatility of markets can be categorized into three classes, these include;

Political risk variables, for example government stability and internal and external conflicts.

Financial