Hedging your rands offshore
How to diversify your risk in a highinflation environment, writes
The World Economic Forum (WEF) “Global Risks Report 2023” highlights soaring inflation as the major risk facing global markets in the year ahead as it drives a global cost of living crisis and forces a shift in monetary policy.
“As demand softens and supply chain bottlenecks ease, global inflation is expected to ease from an estimated 7.6% in 2022 to 4.7% in 2023,” says Philip Robotham, head of intermediary at Schroders South Africa.
The trajectory of US inflation remains a particular concern for investors, says Renzi Thirumalai, investments head at FNB Wealth and Investments.
“Investors are focused on the implication of higher inflation on US interest rates, which are considered a proxy for the future health of the US economy and financial markets and, in turn, will affect global risk appetite.”
Thirumalai says a soft landing, characterised by almost immaculate disinflation without materially affecting the labour market, will have rates peaking around June with minimal further impact on bond and equity markets.
“The hard landing scenario will have the opposite effect, prompting the US Federal Reserve to adopt a more aggressive fiscal tightening approach to curb stubbornly high inflation, which will raise unemployment and cause a shock in both bond and equity
markets.”
Thirumalai believes a mild US recession is the most likely outcome, which will have a modest impact on financial markets.
“Another key concern currently is US company profit margins, which remain cyclically high. These are likely to normalise, especially if the US experiences a recession this year,” says Adriaan Pask, chief investment officer at PSG Wealth.
“In addition, consensus forecasts among analysts remain above trend and elevated, which means profit margin risk is not truly priced in by the markets.”
While these points primarily affect the US environment, Pask says that any turbulence in the US could set the tone for other regions.
Additional risk factors highlighted in the WEF report include trade wars, capital outflows from emerging markets, widespread social unrest, geopolitical confrontations, unsustainable debt levels, a new era of low growth, low global investment and deglobalisation, a decline in human development after decades of progress, rapid and unconstrained development of dual-use (civilian and military) technologies and the growing pressure of climate change.
Despite these risks, investing offshore remains a prudent investment strategy for South African investors, particularly given the weak rand.
“The currency is a crucial consideration for offshore investment given its volatility and impact on return outcomes,” says Thirumalai.
Furthermore, the Reserve Bank expects headline inflation in SA to ease to 5.4% in 2023.
“While inflation is one factor among many that influence exchange rates, it is generally true that higher inflation will likely devalue a currency relative to other currencies where inflation is lower,” says Robotham.
“If local inflation is higher than the global average, we can realistically expect the rand may depreciate relative to other currencies. In this case, holding offshore investments could prove beneficial for rand investors.”
However, currency protection is just one of many benefits to investing offshore, says Wayne Sorour, head of Old Mutual International sales and distribution.
“Investing offshore gives local investors access to a wider opportunity set and helps diversify risk with exposure to multiple sectors, geographies and businesses that you cannot access in SA.”
EMERGING MARKETS
In this regard, Sorour says emerging markets look more favourable now that China has dropped its strict Covid restrictions, effectively reopening its economy.
“Gaining exposure to these markets and sectors such as health care, renewables, semiconductors and automotive, which show positive signs for growth, is vitally important given the low growth projections for the South African economy in the near and medium term,” says Sorour.
Thirumalai adds: “We see the US as fairly valued and would favour opportunities in emerging markets. Europe is also looking attractive, but it is still too early given the region’s reliance on China, and knock-on effects of the Russia-Ukraine war.”
Given the benefits, Sorour believes local investors must maintain their conviction to invest offshore, even at an exchange rate of R18.50/$.
“Local investor portfolios are inherently overweight on SA, which is a troubled emerging market. Investors should use every opportunity to maximise their exposure to offshore markets.”
In this regard it is best to speak to a financial adviser, says Robotham. “An adviser can help you decide the most suitable way to invest offshore based on your individual circumstances.”