Good offshore returns can trump weak rand
● Many South African investors, contrary to good advice, invest offshore at times like these when the rand is weak and either the economic or political outlook is negative.
Ideally, you should invest offshore when the rand is strong against other major currencies such as the dollar or the pound as you will be able to buy more units in a foreign fund or shares on an offshore exchange.
But choosing the right time to invest offshore can be tricky and, according to leading fund managers, it shouldn’t be your main concern, or reason, for investing offshore.
Your motivation for investing offshore should be to benefit from the diversification that an offshore investment can offer you, Allan Gray told investors and financial advisers at recent presentations.
Earl van Zyl, the head of product development at Allan Gray, says many people, including leading local managers of offshore funds, claim the rand is the biggest factor influencing returns from offshore investments.
But Allan Gray research shows this isn’t in fact true.
The manager tested the outcome of investing R12 000 a year in an investment tracking the FTSE World Index for 22 years to the end of last year using three different strategies. The three strategies were investing R1 000 monthly, investing a R12 000 lump sum at the best time from a currency perspective each year, and investing at the worst time each year.
The best outcome was for the fictitious investor with perfect foresight who invested when the currency was strongest. After 22 years the investor had $119 288. Investing R1 000 a month regularly, however, yielded only 7% less or $111 471.
Picking the worst time each year to invest for 22 years had the worst outcome of $103 849 — a 15% difference compared to the best outcome you would get if you knew how to time the currency and invested when the rand was strongest.
Van Zyl says while there is a difference in these outcomes, they are not as great as you would expect and there is thus little value in obsessing over whether now is a good or bad time to invest offshore. Instead you should think about how investing offshore fits into your long-term investment plan and the benefits of diversification, he says.
Lourens Coetzee, an investment professional at Marriott, agrees that investing offshore when the rand is strong helps, but the most important aspect to investing is to invest in quality companies with the ability to grow their earnings and dividends over time.
Marriott’s offshore equity investments focus on the world’s best dividend-paying companies — such as Coca-Cola, L’Oréal, Johnson & Johnson, Nestlé and Unilever.
Coetzee says Marriott is expecting to earn a dividend yield of about 3% from these shares. Price growth is more difficult to predict over the short term, but Marriott’s longer-term expectation is for prices to grow 6% annually in line with dividend growth. This should translate into a longer-term total return of 9% a year.
After first-world inflation, at 2%, this is a real return of 7% a year. Over 10 years, this return can double the real value of your investment and offset losses from a strengthening rand, Coetzee says.
Consider the example of a R1-million investment that earns a return of 9% a year over a 10-year investment horizon.
Assume the exchange rate at the start of the investment is R17 to the pound and at the end of the period the rand has strengthened to R15 to the pound. The outcome after 10 years is R2.1-million, or a return of 7.6% a year.
This illustrates that the impact on your return due to the currency strengthening is less than you would expect, Coetzee says. Your return reduces by just over one percentage point a year, so you would still earn a positive annual return of 7.6% over the decade.
Coetzee says this shows you should focus on the underlying investments and their prospects over the next decade as this trumps the impact of currency movements.
Coetzee says no one can predict what the currency will do over the short term. But over the long term the rand is likely to depreciate by about 4% a year because of the inflation differential between South Africa and developed countries. The rand has depreciated on average 4.7% a year against the pound and 5.9% against the dollar over the past 50 years, he says.
If you believe the current exchange rate of R17 to the pound to be a fair exchange rate, then you should expect the rand to depreciate to around R25 to the pound over the next decade, he says.