A recent study on the Taupo volcanic area by the Institute of Geological and Nuclear Sciences published in the NZ Journal of Geology and Geophysics has more relevance for investors than may appear at first glance.

Our country’s volcanic geology is a factor those involved in New Zealand investments should consider when they are deciding on the asset allocation of their portfolios.

A recent report on the Taupo volcanic zone by the Institute of Geological and Nuclear Sciences, published in the NZ Journal of Geology and Geophysics, highlights the issue.

The entire central region stretching through to the Bay of Plenty is one of the most active volcanic regions in the world with 12 active volcanoes and over 30 geothermal hotspots. Taupo itself is a massive volcanic crater 20 kilometres in diameter, making it one of the ten largest in the world.

The first eruption at Taupo occurred 27,000 years ago and it has had major eruptions 28 times since. The last big blow was in AD 181. This eruption was huge and one of the largest the world has seen over the past 5,000 years. It is estimated that 100 cubic kilometres of material was ejected in this eruption – a third of which was expelled in just a few minutes. Scientists believe the eruption column would have been 50 kilometres high. Ash was sent around the world with both the Romans and Chinese writing about an unusual sky colour and atmospheric conditions at the time.

What if another major eruption occurred at Taupo? The scientists estimate that the North Island would be heavily damaged and everything would be affected, starting with air travel. Auckland is broadly downwind, and more so if Mt Taranaki decides to join the party. Ash would cover a wide area, the region around the volcano would be completely devastated and farming would become impossible for a period of time. Vast areas of the North Island would become uninhabitable.

In economic terms, GDP would shrink drastically as tourism, trade and commerce grind to a standstill, interest rates would be reduced to very low levels and our currency would fall sharply.

Some will argue that this discussion is pointless. First, the odds of this happening are very low, second, the affects might not be as bad as we expect and third, if it does happen, we will have more to worry about than our portfolios.

I disagree. Investment advisers are supposed to worry about risk. And the fact that New Zealand is a small country that straddles one of the most active fault lines in the world is worth worrying about. Not only is New Zealand vulnerable to natural disasters but also to an outbreak of a disease that threatens our all-important agriculture sector.

The unthinkable can happen, and investors should be prepared.

We have long recommended clients diversify some of their investments outside New Zealand. Over recent years however there has been a shopping list of rational reasons why overseas investment has been a bad idea. The New Zealand dollar has been exceptionally strong, our share market has done better than most other global markets, our interest rates are higher than overseas, imputation credits are not available on overseas shares, and the Fair Dividend Rate tax rules on global share investments are ridiculously complex.

Despite all of this, we still believe it is important to have a proportion of an investment portfolio outside New Zealand. These days it is very easy to buy overseas shares. Investors can buy funds such as index funds or UK investment trusts, a handful of which are listed on the NZ market, or they can put together a portfolio of global companies.

Whether to hedge the currency or not is a very topical issue. Investors with a high proportion of their portfolio invested overseas may want to hedge some of their currency risk to protect their portfolio against rises in the New Zealand dollar. However, smaller allocations to global assets should generally be left un-hedged, as having exposure to overseas currencies is a key protection against an event that causes our currency to plummet.

New Zealand is a wonderful place, but a small place. It is therefore prudent to carry some form of country insurance, and for those involved in investments we regard offshore holdings as insurance against ‘New Zealand risk’.