The risks when investing offshore | Fin24
 
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The risks when investing offshore

Apr 16 2019 08:00
Amanda Visser

There is no perfect time to invest offshore, mainly because of the many factors at play. Exploring foreign investment markets can be complex and holds several risks.

Some of these risks include currency volatility; a lack of liquidity in smaller markets; or the risk that despite owning many shares, investors could still be exposed to the same underlying variable or factor; and tax risk.

Chris Potgieter, head of Old Mutual Wealth Private Clients Securities, says the economic centre of the world is shifting towards the south and the east, yet the centre of the global equity market remains very much in the north and west.

South African investors are overweight SA investments and underweight the world, and global market participants are overweight the US and with very limited exposure to the long-term growth drivers of the world – emerging markets.

However, emerging markets tend to be very volatile, with a long history of emerging market crises. “This is nothing new, and investors need to be aware of the risks,” says Potgieter.

Emerging market risks

Although it is a great idea to diversify by investing offshore, SA remains an emerging market.

“Just getting additional emerging market exposure offshore is not necessarily going to leave your portfolio in a better risk-adjusted position,” says James Newell, head of investments for the Maitland Family Office.

Emerging and frontier markets are significantly more volatile, have much less liquidity and have volatile currencies relative to developed markets, warns George Herman, chief investment officer at Citadel, adding that SA investors are already exposed to these risks locally.

Currency volatility

According to Newell, some see exposure to another currency as an opportunity. However, it is important to be mindful of currency risks, especially when investors are reliant on funds for income needs in SA.

The country is experiencing heightened political risk, heightened economic risk and concern of another credit rating downgrade, but Newell says these elements are already priced into the markets to some degree.

This means “that the rand is not necessarily at an undervalued level right now. It is an important risk to consider.”

Tax risks

Many investors have favoured rand-denominated feeder funds because of the perceived complexity of applying for tax and Reserve Bank clearance to invest offshore directly.

However, says Investec sales manager Paul Hutchinson, for discretionary investors (as opposed to investing through a retirement fund or a living annuity product wrapper) the tax consequences favour investing directly offshore rather than through a rand-denominated feeder fund.

He says when investors wind up the offshore structure (direct investment) they have to calculate the capital gain in the foreign currency (dollar, euro or pound) and multiply the gain by the rand exchange rate on the date of divesting.

Therefore, the rand/foreign currency is irrelevant in determining the capital gain.

However, when they disinvest from a rand-denominated feeder fund, any rand depreciation that impacts the valuation of the offshore assets in which the fund is invested, contributes to the capital gain.

“Therefore, you will be subject to capital gains tax on both the capital growth of the underlying assets in which the fund is invested and rand depreciation,” explains Hutchinson.

In an example where an investor invested R1m in a rand-denominated feeder fund compared to a dollar version of almost the same fund, the difference in return was more than R90 000, because of rand depreciation over the investment period.

 Valuations

Allan Gray business analyst Radhesen Naidoo says a key risk facing investors is paying too much for an asset.

 “Ultimately the price you pay today determines your future returns and the risk of permanent capital loss. We have found that purchasing assets below what we believe they are worth, firstly provides investors with less downside risk, and has typically been a rewarding strategy to follow through different investment cycles.”

Maitland’s starting point is also to look at valuations – the price-to-earnings ratio of a share.

If there are sectors that are attractive from a diversification point of view, Maitland will not necessarily invest into those if they feel the assets are overpriced.

Safe asset classes

Naidoo says with increased volatility in global markets, investing in “safer” asset classes such as bonds or cash may be tempting for now.

However, a key risk is not being able to generate real returns in a low interest rate environment.

One of the consequences of a low interest rate environment was that bond investors also entered the stock market in search of “bond-like stocks”, such as defensive stocks that provide a constant dividend and stable earnings, regardless of the state of the overall stock market.

These stocks now appear expensive relative to the broader market.

“Therefore, including these safe assets in a portfolio should be considered carefully alongside other opportunities, as these strategies may not necessarily preserve capital over longer time horizons,” says Naidoo.

This article originally appeared in the 18 April edition of finweek.
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