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In the past 18 months or so, we’ve seen a rush by many investors to take funds offshore, precipitated by the sharp depreciation of the rand following the “Nenegate” debacle in December 2015, and continuing in the wake of “Gordhangate” in March this year and the consequent sovereign credit rating downgrades.
Unfortunately, South Africans have a history of panicking when the rand weakens sharply and responding by taking money offshore.
Because the rand is a highly emotive factor, dominating the news headlines, investors’ immediate focus is often solely on the level of the rand, and not whether an offshore investment actually makes sense from a valuation perspective.
They ignore whether the South African assets they are selling and the foreign assets they are buying at the time are cheap or expensive. They also tend to dismiss the question of whether they actually need to add offshore exposure based on their long-term investment goals.
It is important to remember that we should expect the rand to depreciate against the US dollar over time: on a purchasing power parity (PPP) basis, economic theory tells us that the rand should depreciate by roughly 4% per annum versus the US dollar over time, based on the inflation differential between the two countries.
Surprisingly, it has averaged about 4% p.a. over the longer term, albeit with wide variations over shorter time periods.
So did investors who panicked after notable rand depreciations – in November 1985 and December 2001, and more recently in December 2015 – benefit from moving offshore?
A look at the equity market and currency valuations at those times, as highlighted in the accompanying graph, tells us the results were mixed.
In the graph, the black line depicts the value of the rand on a real effective exchange rate (REER) basis against a basket of currencies.
It shows that, in the 1985 episode, investors would have sold the rand at about 30% cheap, sold South African equities at roughly fair value (as shown by the teal line on a share price/book value basis on the vertical axis) and bought offshore equities at about a 25% discount (depicted by the red line).
After five years, we estimate that this offshore move would have resulted in roughly a 90% benefit to investors relative to staying in South Africa.
However, in 2001 investors did not fare as well. Not only did they sell local equity somewhat cheaply, they also bought offshore equity at 10% to 20% expensive levels, and they sold the rand at an exceptionally cheap 35% discount.
We estimate that, after five years, investors would have benefited by approximately 135% to have stayed in the local market instead of going offshore.
The relatively quick recovery staged by the rand following its 2001 downturn, as illustrated in the graph, contributed to poor offshore returns.
Following Nenegate, the graph shows that the rand was 25% to 30% cheap in the early months of 2016, while both global and South African equity valuations were around fair value to marginally expensive.
Unluckily for those who took money offshore, the rand has subsequently rallied, offsetting most gains recorded by global equities.
Our calculations show that investors who moved R100 000 into foreign equities at the end of December would now have approximately R102 000 (as of the end of June 2017), having experienced negative returns until April this year.
Meanwhile, a South African equity investment has performed better, now worth R110 000, and it has been positive from March 2016.
Although it’s still relatively early after only 18 months since Nenegate, and based on a general example, so far those who panicked and moved funds into global equities have hurt their returns.
It’s clear from these examples that investors looking to take money offshore need to understand the valuations of the assets they are buying and selling, as well as the value of the rand, before they do so.
And of course they should take a holistic view by considering the impact on their overall portfolio and long-term investment goals.
Generally, including some well-considered international exposure in a portfolio has been shown to be beneficial for almost all long-term investors.
What are some of these benefits? Diversification across countries, industries and companies, as well as asset classes and currencies, is the primary benefit of investing offshore.
It reduces the risk of a portfolio for the same expected rate of return, resulting in a more “optimal” portfolio.
At the same time, offshore equities help reduce the risk inherent in the local equity market, which is among the world’s most concentrated.
Offshore assets also provide exposure to growth opportunities, and to world-class companies and industries not available in South Africa – the JSE represents only 1% of the world’s total equity market capitalisation.
Apart from this, having a portion of an investment portfolio offshore acts as a safe haven, helping ease investors’ worries about local markets and making them more likely to stay invested for the longer term.
Additionally, offshore investments can help investors reach their offshore goals. For those who spend significant time outside the country or buy lots imported goods, or wanting to retire abroad or send children to schools outside SA, higher-than-average offshore exposure could prove invaluable.
How much should you invest offshore? This depends very much on your long-term investment goals.
Generally, the offshore portion of your portfolio will be larger the higher your targeted investment return (and therefore the higher the risk required).
For example, if you have a more aggressive return target of inflation + 7%, you would tend to need between 35% to 40% offshore.
A return target of inflation + 6%, meanwhile, is more in line with a typical “balanced” fund with around 30% offshore.
Finally, a more conservative target of inflation + 2% to + 3% would generally dictate offshore exposure of only 10% to 20%.
These are guidelines, however; the exact exposure an individual needs should be determined with the help of a financial adviser.
Prudential is presenting at the Allan Gray Investment Summit on 31 August 2017. Click here for more information.
Pieter Hugo is managing director of Prudential Unit Trusts.
