In­ter­na­tional in­vest­ment: A key el­e­ment of di­ver­si­fi­ca­tion

Finweek English Edition - - INSIDE - In­vestors are able to in­vest in a more di­verse r ange of sec­tors, which gives t hem ex­po­sure to l eadingedge tech­nol­ogy and en­tirely new in­dus­tries. Even though we have global com­pa­nies listed on the Alsi, do­mes­tic in­vestors lack ex­po­sure to tech­nol­ogy, m

In­vestors are reg­u­larly re­minded of the wis­dom of hav­ing a di­ver­si­fied port­fo­lio. By com­bin­ing in­vest­ments that ex­hibit dif­fer­ent re­turn pat­terns, large fluc­tu­a­tions in in­di­vid­ual in­vest­ments can be smoothed out. This means that the over­all port­fo­lio can ben­e­fit from the dif­fer­ent re­turn sources in ag­gre­gate, but with lower volatil­ity of re­turns com­pared to just hold­ing one of th­ese in­vest­ments in iso­la­tion. Port­fo­lio risk in­creases when one is ex­posed to a range of as­sets, mar­kets, sec­tors and cur­ren­cies that be­have in a sim­i­lar way.

As the di­a­gram il­lus­trates, it is crit­i­cal to re­duce down­side risk. Avoid­ing big losses is a proven way of en­hanc­ing longterm re­turns. CON­CEN­TRATED MAR­KETS POSE RISKS We be­lieve widen­ing the op­por­tu­nity set is cru­cial when a do­mes­tic mar­ket is con­cen­trated. The South African eq­uity mar­ket, as rep­re­sented by the FTSE/JSE All Share In­dex (Alsi), is a con­cen­trated mar­ket. While the in­dex cur­rently con­sists of ap­prox­i­mately 165 con­stituents, the five largest stocks by mar­ket cap have a com­bined weight­ing of 39.4%. The Alsi 40, which in­cludes the 40 largest stocks, rep­re­sents the SA large-cap uni­verse and makes up 83% of the mar­ket’s to­tal mar­ket cap­i­tal­i­sa­tion.

In a con­cen­trated mar­ket where per­for­mance is dom­i­nated by a few large- cap shares, in­vest­ment man­agers of­ten end up chas­ing the same stocks. This serves to fur­ther push up the share prices of a few mar­ket favourites and as­set bub­bles can be­come a real risk.

THE CON­CEN­TRATED DO­MES­TIC EQ­UITY MAR­KET MEANS TRUE OP­POR­TU­NI­TIES FOR DI­VER­SI­FI­CA­TION ARE LIMITED. ONE WAY FOR IN­VESTORS TO WIDEN THEIR OP­POR­TU­NITY SET IS BY IN­VEST­ING OFF­SHORE AND TAP INTO A GLOBAL UNI­VERSE OF OP­POR­TU­NI­TIES:

While man­ag­ing volatil­ity is im­por­tant, the val­u­a­tion of off­shore as­sets should also be a key con­sid­er­a­tion. Look­ing at the price earn­ings ra­tio for the South African stock mar­ket, many in­vestors re­gard the mar­ket as be­ing fully val­ued. While some off­shore eq­uity mar­kets have run hard, the large uni­verse of shares means many op­por­tu­ni­ties re­main for as­tute man­agers to un­cover. Steady, if un­spec­tac­u­lar, global growth cou­pled with sub­dued inf la­tion should keep global in­ter­est rates low and be gen­er­ally sup­port­ive of cor­po­rate earn­ings. In turn, this should be pos­i­tive for global eq­uity mar­kets.

For South African in­vestors who in­vest off­shore the volatil­ity of the rand against de­vel­oped mar­ket cur­ren­cies re­mains a ma­jor con­cern. In this re­gard, t he rand has ap­peared par­tic­u­larly vul­ner­a­ble over the past three years.

Some in­vestors may won­der about the wis­dom of in­vest­ing off­shore at the mo­ment, given the weak rand. In our view, at­tempt­ing to pre­dict ma­jor short­term move­ments in the rand is not the premise upon which in­vestors should base their off­shore in­vest­ment de­ci­sions. In­vestors who try to time their en­try into an off­shore in­vest­ment based on the per­ceived value of the rand are tak­ing danger­ous risks.

Ex­change rates rep­re­sent not just rel­a­tive l ong-term macroe­co­nomic f u nda menta l s , but al s o mar­ket sen­ti­ment. It is this mar­ket sen­ti­ment that is re­spon­si­ble for the volatil­ity in our ex­change rate. What we do know is that, over the medium to long term, rel­a­tive pric­ing power and the eco­nomic growth prospects of a coun­try are use­ful in pre­dict­ing the long-term di­rec­tion of its cur­rency. And on both th­ese counts, SA can ex­pect to face a steadily de­clin­ing cur­rency. On a rel­a­tive pric­ing power ba­sis, the rand is cur­rently priced not too far from fair value against the US dollar. So while short-term mar­ket f luc­tu­a­tions in the cur­rency are to be ex­pected, they should not de­ter in­vestors from mak­ing off­shore in­vest­ments.

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