Sunday Times

How much of your liv­ing an­nu­ity should you in­vest off­shore?

- By CHAR­LENE STEENKAMP Business · Finance · Investing · Personal Finance · Retirement · Employment · Society · United States of America · Investec · Schroders · MSCI Inc. · Jaco van Tonder · Sanlam

● 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

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