Cape Town - Not everyone is a fan of paternalistic prescriptions that restrict investors’ choice of where to invest their money.
Regulation 28 of South Africa’s Pension Funds Act imposes limitations on the extent to which pre-tax income can be invested in equities, bonds, property and cash. More contentious is the 25% cap on a fund’s offshore investment allocation, which limits investor’s ability to hedge against slumps in the local currency.
Considering that South Africa contributes less than 0.05% to global gross domestic product and less than 1% of world stock market capitalisation, these restrictions clearly do impose limitations on your ability to invest abroad.
However, Richard Carter, Head of Pooled Business at Allan Gray, says investors should be cautious about adopting “extreme views” on Regulation 28.
“Having limits that encourage prudent investing is certainly not a bad thing,” he says. “But obviously a relaxation on the limit to offshore investment allocations would be welcomed by many.”
While the intention behind asset and geographical restrictions is to protect investors from over-exposing themselves to unnecessary risk, some argue that it actually does the opposite.
Foord Asset Management is known to hold the view that it’s a fallacy that unconstrained investment mandates imply greater investment risk. Their argument is that asset class limitations reduce the number of tools available to a portfolio managers’ to reduce the risk of loss for their clients.
“We feel that the portfolio manager should have the freedom to choose the tools necessary for maximising the investor’s potential for long-term returns, whether they be different asset classes or geographies,” says Mike Soekoe, Head of Global Business Development at Foord Asset Management.
“We’re certainly not against Regulation 28 but if South Africa relaxed the restrictions a little, particularly the cap on offshore investment, we feel we could earn a better outcome for investors.”
One of the most salient arguments in favour of a more laissez-fair approach to offshore investment is the concentration risk of the domestic equity market. The top 10 shares of the JSE All-Share Index, which comprises just 160 shares, account for more than half of the index’s market value.
By contrast the top 10 shares on the S&P500 index, which as its name suggests comprises a far bigger 500 share investment universe, have a mere 17% weighting of the overall index. The S&P500 also offers exposure to an enormous array of technology stocks, perhaps the world’s most exciting and fastest growing sector. The best the local bourse can offer is a handful of distributors of imported hardware and software.
Two of Foord’s own unit trust funds help illustrate the limitations of offshore investment limitations. Over the last seven and a half years the Foord Balanced Fund has returned 12.6% compared to the Foord Flexible Fund’s 16.6%, a differential of four percentage points. When compared to the 10.6% return of the All Share Index that differential climbs to six percentage points.
“That differential is the price you pay for Regulation 28,” says Soekoe.
Foord’s Flexible Fund is precisely what it says it is: a unit trust offering with an unconstrained mandate that allows the portfolio manager to invest in any asset class or jurisdiction that he or she believes will result in the best outcome for investors. That means it’s not burdened by the arbitrary asset class restrictions imposed by Regulation 28. The only snag is that it can only be accessed with after-tax income.
“Technically the fund could have full exposure to offshore assets but it’s highly unlikely that we’d ever have anything higher than a 70% offshore allocation,” says Soekoe.
“Given that the fund is rand-based with the South African investor in mind, we wouldn’t give a 100% offshore allocation because if the rand strengthened it would result in a negative return. However, the beauty of a flexible fund is that it allows us to shift with changing market dynamics without imposed limitations on what the fund manager can and can’t do.”
Soekoe is forthright enough to acknowledge that a lot of the apparent success of the Foord Flexible Fund’s offshore-oriented investment strategy over the last 7.5 years is due to the rand’s decline over that period.
“The rand has certainly been a factor but that in itself is a symptom of some of the challenges being faced by the domestic economy,” says Soekoe. “We still think that equities are a good place to be over a three to five year horizon and offshore continues to offer great opportunities in that space.”
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