Offshore investments aren’t great at beating SA inflation
Your assets should match your liabilities, and offshore equities will have to increase steeply in price if they are to produce returns that will enable them to out-perform South Africa’s inflation rate consistently. Laura du Preez reports Many fund managers may be looking to offshore markets to spice up their returns, but one of the smaller managers says you can diversify a multi-asset portfolio without the risks of investing offshore and provide inflation-beating returns.
Many larger managers have 25 percent of their portfolios offshore and very low exposures to South African listed property, but thanks in part to its small size, Grindrod Asset Management has been able to put 25 percent of its multi-asset portfolios in listed property and diversify into other asset classes, such as preference shares.
Ian Anderson, chief investment officer of Grindrod Asset Management, says it has avoided offshore markets because of the low yields and the low rates of economic growth and company earnings in those markets, whereas the local listed property market has a relatively high yield with room to grow.
Grindrod is not negative on offshore markets, but it is concerned that investors may be investing overseas for the wrong reasons, Anderson says.
Grindrod focuses on investing in assets that are expected to continue to deliver good yields in the form of dividends from equities or income from listed property and other interest-bearing assets.
Most offshore equity markets have an average dividend yield of about two percent, while Grindrod’s local equity portfolios have a dividend yield of 4.5 percent, and its local property portfolios have a yield of eight percent, Anderson says.
Growth in offshore dividend yields is likely to be in line with inflation in offshore markets, which is a lot lower than the local inflation rate of around six percent, he says.
Local dividend yields are forecast to grow at twice South Africa’s inflation rate, and property yields at between seven and nine percent over the long term, Anderson says.
To match the local inflation rate, offshore asset prices need to rise steeply, or your offshore investments could be mismatched with your liabilities, which, if you live here, grow in line with local inflation.
Over the past 11 years, offshore equity markets have out-performed the local inflation rate by just one percent a year, Anderson says.
In addition to the volatility of offshore markets, South African investors face a currency risk when using the unpredictable rand to invest in overseas markets.
Geoff Blount, chief executive officer of Cannon Asset Managers, is also of the view that your assets and your liabilities should be matched. Unlike global equities, South African equities have always beaten local inflation, and interest rates and yields have historically been – and are likely to continue to be – higher in South Africa than overseas, Blount says.
He also takes the view that movements in the rand defy logic, and forecasts are likely to be incorrect.
The rand’s recent “wobble” has many investors again asking whether or not they should invest offshore and, if so, how much of their portfolio to allocate, he says.
But the rand should not inform your decision; instead, Blount says, you should match your assets to your liabilities, consider the need to diversify into industries not represented in South Africa, and understand the long-term cycles in local and offshore markets and how the valuations of assets such as shares affect performance.
Over the past 30 years, there have been extended periods of superior returns in offshore and local markets, and these have been followed by extended periods of sub- par returns – nothing out-performs forever, Blount says.
From the mid- 1990s until the early 2000s, South African equities were characterised by poor returns, whereas global equities produced great returns when measured in either United States dollars or rands. These roles were reversed during the 2000s: South African equities had a decade of excellent returns and global equities had a decade of dismal returns in rand and dollar terms (see graph above).
The 1990s were a period of rand weakness and the 2000s a period of rand strength, but the movements in the currency had less of an influence on equity returns than the movements in the share markets themselves, Blount says.
At the end of the 1990s, he says, offshore share markets had very high valuations (share prices relative to company earnings), whereas South African shares had attractive valuations, and these drove the high returns from local equities of the next 10 years.
Valuations, measured in terms of price-to-earnings ratios (PEs) that show how cheap or expensive a share or an index is relative to its earnings, are crucial to longer-term returns, Blount says. Cyclically adjusted PEs use seven- year, or through-the-cycle, earnings.
Currently, South African equities are on a cyclically adjusted PE of 16.1 times, against a long-term average of 15.7; global equities are on a PE of 16, which is in line with their long-term average; and US equities are on a PE of 18.2, which is above their long-term average of 16.5.
Although the local market is marginally more expensive than global equities and cheaper than US equities, the valuation differences are not compelling enough to motivate a wholesale switch to another market, Blount says.