How much of your living annuity should you invest offshore?
● Retirement savers are constrained by regulation 28 of the Pension Funds Act, which keeps their offshore exposure to 30% of the fund.
But retired investors, who have invested their retirement savings in living annuities from which they draw an income, are not bound by these restrictions. They are free, within the constraints of the funds and investment platforms they use, to set their own offshore allocations.
But deciding on an optimal offshore allocation is not an easy task.
Like many investment houses, PPS Investments and Schroders expect that the rand will continue its decline over the long term.
Gavin Ralston, head of official institutions and thought leadership at Schroders, says political uncertainty, low economic growth, high unemployment and a high percentage of debt that is financed from foreign capital, make the rand vulnerable to changes in the US dollar as well as to sentiment towards emerging markets.
Long term, Schroders expects the rand to depreciate against the dollar by an annual average of 5% over a seven-year period, Ralston says.
Reza Hendrickse, portfolio manager at PPS Investments, agrees that in the long term the rand is likely to weaken against the dollar, with periods of volatility as a result of emerging-market, global and domestic issues.
When it comes to returns, those of the past 10 years show you could have added appreciably to your return each year by investing in global stocks as opposed to South African stocks (for the 10 years to June 30 2018, the MSCI SA returned 7.1% and the MSCI World 10.1%, in rands).
Schroder’s forecasts suggest that this differential will remain even if SA achieves higher growth rates because of structural reform.
This outlook implies that South African investors should be aiming at a high weighting in offshore assets. SA makes up less than 1% of global market capitalisation and the bias for investing in home markets is extreme in SA, Ralston says.
Jaco van Tonder, adviser services director at Investec Asset Management, says you should add offshore equities to a living annuity because the returns are highly uncorrelated with those of local fixed-income assets often favoured for their ability to earn an income for those on a living annuity.
He says Investec’s initial research suggests offshore exposure should be as high as 40% for living annuitants drawing an income of 5.5% to 6% of their invested savings.
Investors drawing between 4% and 5.5% should have more than 30% of their investments offshore, he says.
He concedes that this research is based on a time when shares on the JSE largely had earnings in rands. But even if you allow for the substantial offshore earnings in JSE-listed companies today, investors should still have at least 25% of their living annuity portfolio invested offshore, he says.
In an article for Glacier by Sanlam earlier this year, Luke McMahon, research and investment analyst, said your allocation to foreign assets classes will depend on the return above inflation you are targeting, but optimal allocations for portfolios targeting aboveinflation returns is more than 25% and for those targeting between 5% and 8% above inflation, it is more than 35%.
However, MacMahon notes that increasing your foreign allocation in portfolios that target higher returns also diminishes your chances of reaching your target return over shorter three-year periods. For example, the chances of reaching this return on a rolling three-year period is just 50%.
When returns are not delivered in a straight line, investors who are drawing a regular income face the risks that come with the sequencing of returns — the order in which returns are delivered.
Hendrickse says there is a threshold above which greater offshore exposure becomes increasingly risky because of currency volatility, but PPS thinks it is appropriate to have your offshore exposure between 25% and 30%, with the bulk of that invested in global equities.
Both Hendrickse and Shaun Duddy, manager of product development at Allan Gray, say the size of the allocation should be a function of the returns you require, your appetite for risk, your investment time horizon and your circumstances.
Duddy says research on the average South African household’s spending habits on imported goods/services, suggests that investors should aim to hold at least 30% to 40% of their total investment portfolio in assets that generate their returns offshore, to protect against a potential erosion in local purchasing power.
Zain Wilson, portfolio manager at Old Mutual Investment Group, says some investors are questioning whether they should be invested 100% offshore, but because your future liabilities — where you will spend your money — are predominantly rand-based, putting everything offshore would expose you to “unpalatable currency risk”.
He says the rand has a significant impact on the shorter-term returns you experience from global investments as a South African investor. This is illustrated by three periods in which the currency was either strong or weak:
● Just after the global financial crisis in 2009 to 2010, the rand was strong and South African equities delivered three times more than global returns.
● Between December 2010 and January 2016, the rand was weak as the expected economic recovery in SA failed to materialise and political woes reached a peak with the firing of finance minister Nhlanhla Nene — global equities delivered 15% more than local equities.
● Between January 2016 and December last year, the rand was strong and local equities delivered almost three times more than global equities, Wilson says.
Despite this, he says you shouldn’t try to time the market by attempting to anticipate what the unpredictable rand will do, but rather look towards portfolios that give balanced exposure, to capitalise on both local and offshore opportunities. — Additional reporting by Laura du Preez