There is no magic number when it comes to determining how much you should invest in offshore markets, independent financial planner Ian Beere told the recent acsis/Personal Finance Financial Planning Club meetings.
Beere, who won the 2007 Financial Planner of the Year award – sponsored by the Financial Planning Institute and Personal Finance – says the reasons you have for investing offshore and your personal circumstances should dictate how much you invest.
A long-lost uncle leaving you an inheritance in a foreign country or a dim view of the economic and political circumstances in South Africa may not on their own be reason enough to invest offshore, he says.
You need to consider your personal circumstances in light of five reasons for investing offshore, he says.
You also need to analyse your current investments to see how much you have in various asset classes, how much is invested offshore and locally, and to what degree your local assets act as a buffer against a falling rand because they have offshore exposure, Beere says.
1. Where your future liabilities lie
The most important reason to consider investing offshore is to match your assets to your liabilities. Beere says a major portion of your investments are best invested in the country in which your future living expenses will be incurred.
So if you are saving, for example, for your retirement and plan to continue living in South Africa, you should have the bulk of your savings in South Africa, because the future liability your savings will need to meet is to pay you an income for the duration of your retirement.
If you are planning on retiring in Australia, for example, because your children have emigrated there, you should have the bulk of your retirement savings there.
This is because returns on equities, bonds and property in a particular country will generally follow that country’s inflation rate more closely, enabling you to have greater certainty that your investments will grow in relation to the rate at which your future living costs will grow in that country, Beere says.
If you are planning to retire in South Africa but want to travel extensively to visit your family in Australia, you should invest a portion of your savings for that purpose in that country.
This will have the effect of locking in the affordability of your trips irrespective of what exchange rates do in the future.
Beere says while the bulk of your savings should be in the country in which your future liabilities lie, you should have some offshore exposure to match the liabilities you face that are driven by other currencies.
For example, he says, in retirement part of your income will be required to fund transport that is dependent on the petrol price, which, in turn, is dependent on the rand-dollar exchange rate.
Exposing a reasonable portion of your savings to a dollar-based investment could match this liability.
Beere says if you invest offshore to match a future liability in a foreign currency, you must accept that that is your strategy, and don’t be disappointed when a rand-based investment offers a better return.
2. Diversification into global brands
Another good reason to invest offshore is to diversify into markets, industries and companies that are not represented in South Africa, Beere says.
Good diversification will expose you to a spread of returns, so you do not have all your eggs in one basket. You should then enjoy good returns from various regions or industries or asset classes, even when one does badly.
Nestle and BMW are examples of products we are familiar with in South Africa, but whose shares are not listed on the local market and must be bought overseas.
3. Tactical asset allocation
You should consider current local market opportunities relative to overseas market ones when you consider investing offshore.
When you make tactical asset allocation decisions you make a call to adjust your investment portfolio by taking some money from local assets and adding it to offshore assets because you believe they offer better value and are more likely to perform well in the future.
Currently, you may want to consider tilting your investments towards offshore markets, because local markets have, in recent years, performed very well relative to offshore ones, Beere says. This has resulted in the price-to-earnings ratio (p:e) of local assets rising to a point where finding shares that offer value is more difficult, he says.
The p:e is the price of the share divided by its earnings, and it shows how long it will take to get back in earnings the price you paid for the share. It is also an indication of how expensive the share is. The cheaper the share, the better its return (over a five-year period) should be.
Beere says an analysis of returns of the FTSE/JSE All Share Index shows that, on average, the rolling five-year returns earned by the index from 1960 to date are closely correlated with the p:e at which you bought into the market.
This means that the returns decrease as the p:e at the time of investment increases. For example, if you bought into the market at a p:e of 10, you would have had an average return of nine percent above inflation, but if you bought into the market at a p:e of 18, you would have had only a three percent return above inflation.
4. Access to an unrestricted currency
You can now take R1 million out of the country for investment, travel and certain other purposes with minimal formalities. This is in addition to the R4 million you can take out annually for investment purposes. This allows a couple to invest R10 million a year in investments in foreign currencies, which means exchange controls affect very few.
Beere says while exchange controls that restrict your right to move your money in and out of the country have been eased a lot in recent years, these transactions remain controlled by the Reserve Bank.
South African residents wanting access to foreign-currency funds should set this up while it is possible. Beere says while he hopes exchange controls will continue to be relaxed in the future, circumstances could arise that would result in the Reserve Bank restricting the flow of money out of the country.
5. concerns about political risk
Beere says you may also want to invest offshore because you are worried about the impact local circumstances may have on your investments in South Africa.
These circumstances include the huge wealth gap between rich and poor, high unemployment, political leadership challenges, and the tendency to resort to violence to resolve problems.
South Africa has recently been downgraded by two investment rating agencies on the back of, among other things, political uncertainty. This is probably the biggest driver of a portfolio being over-weighted offshore, Beere says.
WAYS TO INVEST OFFSHORE
There are two ways in which you can get exposure to offshore investments.
One way is to convert your rands into a foreign currency and invest directly in shares, property, bonds, cash, alternative investments or mutual funds (unit trusts) in foreign markets.
Alternatively, you can get exposure to offshore markets without converting your rands into a foreign currency by investing in a rand-denominated unit trust that invests in foreign markets.
An investment in local rand-hedge shares will also give you protection from the falling rand, but may not satisfy your other reasons for investing offshore, Beere says.
Rand-hedge shares, such as SAB Miller, are listed on the JSE but earn their income from other countries. If the rand weakens, the turnover of these companies tends to increase, he says.
He gives some of the advantages and disadvantages of the two ways:
* All the growth accrues in a foreign currency and can be withdrawn anywhere in the world.
* You have to obtain Reserve Bank approval and comply with exchange control limits (essentially you have a limit of R5 million a year).
* To use your offshore allowance, you will need a South African Revenue Service certificate saying your tax affairs are in order.
* The costs of converting your rands into foreign currency, especially in the case of small amounts or regular transfers, can be high.
* You may need an offshore will and your heirs will have to deal with offshore estate assets when you die.
* You need to keep good records.
Investing in rands
* No Reserve Bank approval or tax certificate required.
* You can make monthly contributions or withdrawals from as little as R500 a month. Lump-sum top-ups and withdrawals are easy to do.
* A local trust can obtain exposure to offshore assets in this way.
* You will enjoy the full offshore return but your investment always pays out in South Africa in rands.
Benefits of using a fund
If you invest directly into an offshore market, you need to understand these markets, Beere says.
The advantage of using a mutual fund or rand-denominated foreign unit trust fund is that the fund manager decides for you how to allocate your money between different asset classes and different regions and countries.
The manager will choose the assets and can even manage the fund’s exposure to a particular currency, if that currency is expected to devalue.
Beere says that using an offshore endowment policy can be useful, if it is not too expensive. Tax is paid on your behalf and you can nominate a beneficiary, keeping the investment out of your estate when you die.
TAX ON FOREIGN INVESTMENTS
Investments in a foreign currency are subject to tax in South Africa if you are resident here.
Interest and dividends on your foreign investments are taxed as income, subject to certain exemptions, Ian Beere says.
You will also pay capital gains tax on capital gains you make on these investments. Each year you are entitled to an annual exclusion on capital gains. Thirty-three percent of the gains made over and above the exclusion are added to your taxable income and taxed at your marginal rate of tax.
WHEN TO INVEST
There are two things to consider when you decide on the best time to invest offshore, Ian Beere says.
The first is the exchange rate between the rand and the currency in which you plan to invest.
Beere says while the rand has weakened recently, when you consider longer term trends, it is currently not too far off fair value relative to the US dollar and inflation differences over time.
However, he says, South Africa’s high current account deficit and the government’s budget deficit pose a risk that the rand may weaken. To mitigate this risk you need to invest for the long term, Beere says.
The other factor to consider when you decide on the best time to invest is the valuations or price-to-earnings ratios (p:e’s) in offshore markets. Currently there are more shares overseas with better p:e’s and higher dividend yields than there are locally, he says.