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The first half of 2016 has 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.
Unfortunately, South Africans have a history of panicking when the rand weakens sharply and responding by taking money offshore.
The rand is a highly emotive factor, so 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’s 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% per annum 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 markets and currency valuations at the time tells us the results were mixed. In the graph, the grey 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 a 30% discount, sold South African equities at roughly fair value (as shown by the red line on a share price-to-book value basis) and bought offshore equities at about a 25% discount (depicted by the blue line). After three years, we estimate that this would have resulted in about a 15% 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 cheap, they also bought offshore equity at a premium of 10% to 20%, and they sold the rand at an exceptionally cheap 35% to 40% discount. We estimate that, after three years, investors would have benefitted by approximately 121% if they had stayed in the local market instead of going offshore.
The relatively quick recoveries staged by the rand following its 1985 and 2001 downturns, as illustrated in the graph, contributed to poor returns.
In the most recent rand depreciation, the graph shows that the rand was trading at a discount of 20% to 25% in the early months of 2016. It also highlights why this bout of currency weakness has been particularly painful for investors: the currency moved from an expensive peak in December 2010 to a very cheap position, a large swing in five years.
However, it still didn’t manage to reach as cheap a level on a REER
basis as it did in 2001. Meanwhile, both global and local equity valuations
have been marginally expensive so far this year.
Unluckily for those who took money offshore after Nenegate in December 2015, the rand has subsequently rallied, while the local equity market outperformed foreign equities.
Our calculations show that investors who moved R100 000 into foreign equities at the end of December would be left with R94 533 as of the end of June 2016, while a South African equity would be worth R104 324. This R10 000 differential is a substantial sum over only six months. However, it’s worth noting that this is also a very short time period for measuring investment returns; three years would be a more appropriate timescale, as in the other two cases.
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 of the impact on their overall portfolio and long-term investment goals. Although it is the vagaries of the rand that capture the news headlines and grab investors’ attention, it is not the only factor that matters in such an important decision.
Pieter Hugo is managing director of Prudential Unit Trusts.
This article originally appeared in the 15 September edition of finweek. Buy and download the magazine here.
