Why offshore investment approach makes sense
Foreign markets offer access to a far broader and more diversified opportunity set
After years of mismanagement and decline, SA s economy is in a diabolical state. Earlier this month Stats SA announced that GDP had contracted 51% (based on annualised quarter on quarter numbers) in the second quarter while tax revenues are set to plunge following the economic shock of the Covid lockdowns.
Against this backdrop, additional expenditure will be required to try to stimulate the economy. However, as expenditure rises, SA will run a huge deficit, explains Andrew Duvenage, MD of NFB Private Wealth Management.
The runaway public sector wage bill and government s apparent inability or unwillingness to address this
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coupled with the drain on the fiscus of SOEs are longer term, structural issues,” he says. The
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deficit will need to be financed and given the already unsustainably high levels of debt in SA, a debt trap is no longer a risk but rather a reality.”
Coupled with the downside risk to the economy is significant downside risk to the rand, adds Duvenage, making offshore diversification not just sensible, but essential. The
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reality is that when an economy suffers, so too will many of the participants in that economy. There is a very real risk South African-based investments will suffer significantly.”
Consider, he says, SA-facing as opposed to rand hedge
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stocks on the JSE which clearly show the recent JSE recovery is not broad-based. On aggregate price to earnings (PEs) ratios are high with the real risk asset prices go sideways or even backwards in the likely absence of meaningful earnings to support these price levels.
We are likely to see a shrinking and concentration within the JSE. This will result in the opportunity set available to investors becoming smaller. From a diversification perspective it is therefore imperative investors have exposure to foreign markets which offer access to a far broader and more diversified opportunity set.”
Given that there are multiple ways for local investors to gain access to offshore investments, the question is which is the most optimal route? There is no one-size-fits-all approach as every investor s circumstances
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and needs are different, says
Duvenage. Factors to consider, he says, are the nature of the investor (whether the investor is an individual, trust or company influences the available options), the available capital (is it viable to physically take funds offshore or is a local feeder fund more appropriate), liquidity requirements (offshore investments and asset swaps tend to be less liquid than feeder funds), risk tolerance (which will determine the underlying asset allocation) and tax requirements which will also influence the available options.
It s important to choose the right investment option for your particular risk profile. The mix between equity, property, bonds, cash or structured investments will be driven by risk appetite and the investor s
’ ability to deal with volatility,” says Duvenage.
In the current low or zero interest rate environment it is likely investors and global capital will gravitate towards equity, with dividend yields being seen as a proxy for yield, he points out. However, while this may well support and drive equity prices up, investors need to understand the risk they re
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exposed to. Whereas in the past
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investors may have held a significant weighting to defensive assets like cash or high quality bonds, they may now feel the near zero returns are totally unattractive and they should therefore upweight equity exposure. This can potentially result in a misalignment of risk profile.”
When it comes to offshore investing, says Duvenage, a number of basic principles apply. First, diversification is key. Second, understand the credit risk. Third, be patient when entering offshore markets. Given the volatility of the rand, following a strategy of regularly exiting the rand may make sense as it could mitigate against the risk of externalising at unfavourable rates (a cost averaging approach). Last, the time horizon is vital. Offshore investments should be seen as a long-term strategic asset.
He says investors need to be cognisant of risk and longer time horizons to deal with potential volatility. As a South
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African investor, offshore investments are inherently more volatile as they have two dynamics in place: currency risk and an underlying investment risk. While the evidence all points towards long-term rand depreciation, it is entirely possible the rand
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often counterintuitively
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strengthens in the short term, negatively impacting the value of the offshore investment. This volatility is particularly challenging for cautious investors, or those who are drawing from their portfolios.”
The key with offshore investing is that it should be seen as a long-term, strategic investment decision.
Tactical trading of currency movements may well produce results for some, but is undoubtedly a high risk strategy,” says Duvenage.
IN THE CURRENT LOW OR ZERO INTEREST RATE ENVIRONMENT IT IS LIKELY INVESTORS AND GLOBAL CAPITAL WILL GRAVITATE TOWARDS EQUITY