Di­ver­si­fi­ca­tion in a low-re­turn en­vi­ron­ment

It’s clear that we’re mov­ing into a lower-re­turn in­vest­ing en­vi­ron­ment, cre­ated by myr­iad po­lit­i­cal, eco­nomic and so­cial fac­tors play­ing out on the world stage. How should in­vestors adapt their ap­proach – if they should do so at all?

Finweek English Edition - - FUND FOCUS - Kent Grobbe­laar is port­fo­lio man­ager at Stan­lib.

change is the only con­stant, and in­vestors need to re­spond to each shift that oc­curs around them – even if that re­sponse is to an­a­lyse the data available to them and stay the course. The cur­rent shift is away from the high-re­turn en­vi­ron­ment that we’ve en­joyed over the past few years, to­wards much lower re­turns – and smart in­vestors will iden­tify a strat­egy to mit­i­gate the in­evitable neg­a­tive im­pact of this sce­nario. One way in which to do this is to en­sure your in­vest­ment port­fo­lio is suf­fi­ciently di­ver­si­fied.

In a glob­ally con­nected world, these shifts and trends im­pact how in­vestors in South Africa should de­cide how best to po­si­tion their port­fo­lios. Should lo­cal in­vestors con­sider off­shore in­vest­ing?

Hedg­ing against the rand

Since the 1970s, the rand has lost over 90% of its value against the dol­lar in nom­i­nal terms. It would there­fore come as no sur­prise that most peo­ple would list hedg­ing against fur­ther cur­rency de­pre­ci­a­tion as one of the great­est ben­e­fits of in­vest­ing off­shore.

In some in­stances, it’s those very same peo­ple who may have rec­om­mended in­vest­ing in the Bric (Brazil, Rus­sia, In­dia and China) na­tions. These emerg­ing economies with favourable pop­u­la­tion dy­nam­ics did not suf­fer from the in­debt­ed­ness of many of their de­vel­oped mar­ket coun­ter­parts.

The fact that the Rus­sian rou­ble and Brazil­ian real de­pre­ci­ated by more than the rand over the last five years high­lights the im­por­tance of “where” in the equa­tion. Suf­fice it to say the rea­sons for the rand’s plight, such as po­lit­i­cal risk and com­mod­ity sen­si­tiv­ity, are well-doc­u­mented so I won’t elab­o­rate fur­ther.

The point is this: given the con­straints of ex­change con­trol, in­vestors should max­imise the po­ten­tial of di­ver­si­fi­ca­tion through in­vest­ing in un­cor­re­lated as­sets, and a weak rand is only a part of a broader con­sid­er­a­tion. The best ap­proach is a multi-spe­cial­ist one that grows your money across bor­ders, over­com­ing any blind spots lurk­ing in a sin­gle mar­ket.

Com­par­ing SA to the rest of the world

Another way of look­ing at this is to con­sider the South African eq­uity and bond mar­kets rel­a­tive to the rest of the world. When viewed in this con­text it be­comes clear a home bias re­ally and truly lim­its what you can in­vest in. SA rep­re­sents a mere 0.2% of global debt in­dices with only 60 se­cu­ri­ties out of 20 708 in the broader Bar­clays Mul­ti­verse In­dex, and our GDP is just 0.51% of the world’s econ­omy.

Hav­ing spo­ken to many clients over the years, it’s ap­par­ent that South African in­vestors are woe­fully un­der­weight in off­shore as­sets. If di­ver­si­fi­ca­tion has been a pro­duc­tive strat­egy for a na­tion whose stock mar­kets rep­re­sent half the globe’s mar­ket cap – the United States – how much stronger is the ar­gu­ment for South African in­vestors, where the JSE is a mere 0.63% of the in­vestable uni­verse?

Put dif­fer­ently, we be­lieve the 25% per­mis­si­ble off­shore within pen­sion funds is not suf­fi­cient di­ver­si­fi­ca­tion (bear­ing in mind most of an in­di­vid­ual’s net worth is prob­a­bly in their house and other lo­cal as­sets).

Should for­eign eq­ui­ties and bonds be in­cluded, we would only ob­serve a di­ver­si­fi­ca­tion ben­e­fit if port­fo­lios gen­er­ated su­pe­rior re­turns, lower risk, or both. We as­sess this by cal­cu­lat­ing real rand re­turns ver­sus real risk as mea­sured by an­nu­alised stan­dard de­vi­a­tion of real re­turns, also known as volatil­ity. If the re­turn per unit of risk rises when adding for­eign as­sets, the port­fo­lio is be­ing en­hanced.

In an in­creas­ingly in­ter­con­nected world, an abil­ity to see the big­ger pic­ture in these ways re­duces risks, en­ables real time re­spon­sive­ness, and op­ti­mises growth, for busi­ness and for in­vestors.

We think it doesn’t make sense to take on risks which are eas­ily di­ver­si­fi­able. To this end cer­tain sec­tors are not well rep­re­sented in SA. Us­ing in­for­ma­tion tech­nol­ogy (IT) as an ex­am­ple, SA sim­ply does not have the depth and va­ri­ety of tech­nol­ogy com­pa­nies available to Amer­i­can and Euro­pean in­vestors. Other sec­tors which are al­most non-ex­is­tent or poorly de­vel­oped are health­care and util­i­ties – although it is worth not­ing that this is not a specif­i­cally South African or

emerg­ing-mar­ket chal­lenge.

Broader global in­dices are much more di­ver­si­fied.

We be­lieve that in­vestors should look at a broad range of ben­e­fits pro­vided by off­shore in­vest­ments. Hedg­ing against cur­rency de­pre­ci­a­tion should not be the sole pur­pose. Spread­ing as­sets across sev­eral coun­tries as well as ac­cess­ing op­por­tu­ni­ties in sec­tors and com­pa­nies which may not be available lo­cally just makes sense. Our sta­tus as an emerg­ing mar­ket tends to make our ex­changes more volatile than First-World bourses and this is some­times com­pounded by fac­tors which are dif­fi­cult to fore­cast, like a drought or pol­i­tics.

Be care­ful

A word of cau­tion, how­ever: the next 10 years may look very dif­fer­ent com­pared to the last decade. The rand is con­sid­ered one of the most un­der­val­ued cur­ren­cies in the world. Any strength­en­ing from cur­rent lev­els will un­doubt­edly have an ad­verse im­pact on fu­ture re­turns of non-South African as­sets. While it’s no­to­ri­ously dif­fi­cult to fore­cast the rand, it’s worth high­light­ing that it has his­tor­i­cally bounced back from such ex­treme or over­sold lev­els.

To put it into per­spec­tive, af­ter be­ing abroad for a while, I re­cently met up with work col­leagues and was amazed by how cheap al­co­hol and Big Macs are in SA. I did some re­search and found a sur­vey that showed that the cost of beer in a neigh­bour­hood pub is cheaper in Jo­han­nes­burg than most places in the world! Ac­cord­ing to www.ex­patis­tan.com a pint only costs a quar­ter of an equiv­a­lent bev­er­age in Lon­don (although this data is pre-Brexit). I can en­dorse this sur­vey and ver­ify its ac­cu­racy, so you can ei­ther drown your sor­rows be­cause the rand is weak, or en­joy the qual­ity of life that a weak rand en­ables!

Ei­ther way, a pru­dent ap­proach to in­vest­ing off­shore from cur­rent lev­els would be to fol­low a stag­gered ap­proach to in­creas­ing ex­po­sure.

Hedg­ing against cur­rency de­pre­ci­a­tion should not be the sole pur­pose. Spread­ing as­sets across sev­eral coun­tries as well as ac­cess­ing op­por­tu­ni­ties in sec­tors and com­pa­nies which may not be available lo­cally just makes sense.

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