Cape Town - The stellar slump in the rand, a bleak outlook for the domestic economy and the looming prospect of a possible sovereign ratings downgrade has got many a South African investor considering how and if they should place a portion of their portfolios in offshore investment vehicles.
“Interest in offshore investments has ramped up massively in the last two months,” says Tamryn Lamb, head of Orbis client servicing in South Africa. Orbis is Allan Gray’s offshore investment partner.
South Africa’s gross domestic product shrank 1.3% in the second quarter adding further anguish to an economy already grappling with electricity shortages, falling commodity prices, labour unrest and woeful consumer sentiment.
“Offshore investment should form part of your long-term investment strategy,” says Lamb. “You should guard against making kneejerk decisions.”
One of the most prominent arguments in favour of investing offshore is to diversify your portfolio and in so doing reduce some of the so-called concentration risk in the local equity market. The top 10 shares of the JSE All-Share Index, which comprises just 160 shares, account for more than half 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.
“In the US there are at least 500 companies with a market value of $1bn or more in the tech sector alone,” says Lamb. “We don’t have access to that kind of opportunity set in South Africa. We believe that having exposure to offshore assets allows you to gain access to this wider opportunity set. How much you put offshore should depend on your own personal circumstances, return objectives and risk tolerance.”
Unfortunately under current legislation South African investors can only allocate 25% of their portfolios to offshore markets (although a further 5% can be invested in the rest of Africa). Of course, this restriction only applies to pre-tax income. You are quite entitled to invest after-tax income, or an accumulated cash lump sum, into offshore investment vehicles.
The question though is whether now is the right time to go offshore, given that the rand has lost significant ground against its international peers and continues to trade near record lows against the dollar, euro and pound.
“If you go offshore now, or at any point, it is imperative that you do it as part of a long-term strategy and each investor should be very clear on the underlying rationale for doing so, be it hedging against the currency or as part of a wider diversification plan,” says Lamb. “Don’t make decisions which are based on a short-term panic move and don’t make this decision based on your `point in time’ view of the level of the rand.”
The flipside of this question is whether the current weakness in the rand presents the ideal opportunity for investors who already have a sizeable offshore investment portfolio to repatriate some of that money back to South Africa.
“If you bring your money back now and invest it in South Africa you are still faced with the same local challenges of this economy,” says Mike Soekoe, Head of Global Business Development at Foord Asset Management. “Long-term there are still a lot of negatives that we think will keep the rand on the back foot.”
Soekoe says Foord’s view is that the rand’s fair value is around R14 and R14.50 per dollar given the challenges facing the South African economy.
Then there is also the not insignificant issue of a potential ratings downgrade, which could put further pressure on the domestic currency. Concern that South Africa may lose its investment grade debt status was heightened after Standard & Poor's cut Brazil’s rating to junk status in September.
An informal poll of economists by Fin24 at the end of September pretty much put the likelihood of South Africa being cut to junk status at around “fifty-fifty”. Investec Economist Annabel Bishop says Fitch is expected to cut South Africa’s debt rating in December, meaning it will join Standard & Poor’s in assigning a BBB- rating for the country, which is the lowest investment grade rung.
That’s not to say investors should attempt to time the market by going into an offshore fund in anticipation of a downgrade. If South Africa does suffer a downgrade it will simply illustrate the folly of maintaining a 100% exposure to a single emerging market at the tip of Africa.
“It is impossible to time it perfectly and focusing on when to invest offshore – based on your current view of the rand – is likely to result in a decision made on an emotional rather than a rational response which will impact the long term returns you are likely to achieve,” says Lamb.
“Given the recent sharp depreciation of the rand, there is always a probability it could strengthen from here - or it could continue to weaken. Recognise this risk, but don’t let it govern your long-term investment strategy.”
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