Investing everything offshore could hold nasty surprises
Since the withdrawal by the Treasury, SA Reserve Bank and Financial Sector Conduct Authority of the exchange control circular issued by the Bank on the capital flows management framework, misinformation continues to be peddled to unsuspecting individual savers and investors.
There is an interest group that says regulation 28compliant funds should be allowed to increase their offshore exposure outside Africa from the current 30% all the way to 100% because offshore asset classes have outperformed domestic asset classes. There are various factors that cause this line of thinking to be misaligned with what is in the best interests of most South Africans.
First, for the majority of South Africans 100% of their liabilities — school fees, mortgage payments or rent, food expenses — are in SA and denominated in rand, which also means they must be settled in rand. Having 100% of their investment offshore is therefore not the most prudent investment strategy.
From 2000 to 2019 the rand, during years that it appreciated against the US dollar, gained an average of 12.8% a year. During the years it depreciated, it lost on average 15.8%. Unmasking the averages, the rand appreciated by as much as 34% and depreciated as much as 60% in a single year. For most vanilla investment products that are unhedged, the offshore returns have to be at a minimum of the rand’s appreciation rate to have a rand return that is positive; that is on average 12.8% per year, or as much as 34% if we consider the years that the rand appreciated.
The reason is that when the rand appreciates it erodes the rand return of offshore investments denominated in foreign currency. Currency movements can be hedged, but this usually comes at a cost and reduces the returns. Imagine a worker who has saved in a pension fund their whole working life retiring in a year when the rand appreciates by 34% if the fund has been invested 100% offshore. If the offshore return is less than 34% there will be capital erosion in rand terms. This is a basic principle savers and individual investors must always be mindful of when they hear advocates for offshore investing preaching to them to take all their money out of the country. Liabilities are in rand terms and the rand movements can enrich or impoverish them if not managed. The cost is not zero.
Second, regulation 28 funds, which now limit offshore exposure outside Africa to 30%, have tax benefits afforded to pension fund savers. This is not available to noncompliant regulation 28 investors. Investments that can have 100% offshore exposure rarely beat regulation 28 funds in rand terms once the tax benefits are considered. For providing the tax benefits to savers the government must have the right to influence where the savings are invested in the domestic economy. For those who want 100% offshore exposure it is only fair that they not get the tax benefit, and the returns alone rarely beat regulation 28 funds.
Essentially, advocates for higher offshore exposure cannot have their cake and eat it.
Third, development is partly financed by the country’s savings, which includes longterm savings in pension funds. Externalising pension fund savings would starve the country of capital that is needed for financing economic development, capital that would improve the environment in which South Africans retire. Of course, some might want to retire offshore and have greater need for offshore investments to match their future liabilities. The question is why this segment of savers would be afforded an SA tax benefit if their savings do little to develop the economy.
All things considered, offshore exposure is good as a diversifier, but not as the only investment vehicle. While exchange controls have been gradually liberalised over time, expecting offshore allowances to be lifted to 100% while getting tax benefits is absurd. Individual savers must always be careful with such advice, especially without a full assessment of their full financial objectives.