This feature was sponsored by Old Mutual Investment Group
Increasing your offshore investments significantly in a blind panic about the state of the economy and the weakness of the rand is risky, a leading asset manager says.
Many investors are not only worried about further rand weakness, but also the poor state of the local economy and the potential for ratings agencies to downgrade South African government bonds to junk status.
These factors, as well as the removal of Nhlanhla Nene as finance minister, have seen consumer and business confidence plunge, and many investors are asking whether they should invest more offshore, Peter Brooke, the head of Old Mutual Investment Group’s MacroSolutions boutique, says.
The sage advice is that every investor should be diversified into offshore markets, but the percentage of your assets that you should invest offshore depends on where you are in your life, where you plan to realise your investments, your current exposure to offshore and local markets, and the return you require on your investments, Brooke says. Ultimately, the question is “how much is enough?”.
A well-qualified, independent financial adviser should help you to determine your optimum level of offshore assets, Brooke says.
Because the amount you need depends on your circumstances, there is no standard percentage of your portfolio you should invest offshore, but generally, the higher your required return and the more risk you are prepared to take, the greater your offshore exposure should be.
If you invest in a multi-asset, or balanced, fund with an expected real (after-inflation) return of between four and five percent, about 35 percent of that portfolio should be exposed to offshore markets, he says.
Many investors are taking a lot of money offshore, as if they were going to emigrate. This is risky, because your assets (your investments) are not aligned with your liabilities (the spending your investments will have to fund, such as an income in retirement), Brooke says.
If you invest in a multi-asset fund that is an underlying investment in a retirement fund or a retirement annuity fund, the fund’s offshore exposure is limited to 25 percent of the portfolio in terms of the prudential investment guidelines contained in regulation 28 of the Pension Funds Act.
Brooke says many shares on the JSE earn a sizeable portion of their earnings or profits from offshore markets – they are what are known as rand-hedge shares. As a result, most people in a South African multi-asset fund that complies with regulation 28 have sufficient offshore exposure despite the 25-percent limit on offshore assets.
If you have children overseas, spend a lot of time overseas, or have significant unlisted assets in South Africa, such as property and agricultural land, then it may make sense to increase your offshore exposure, but Brooke advises you to seek professional financial advice before deciding on your offshore allocation.
RAND-DENOMINATED UNIT TRUST FUNDS ARE THE EASIEST WAY TO INVEST OFFSHORE
The easiest and simplest way to invest offshore is with a rand-denominated unit trust fund that invests in foreign financial markets.
Peter Brooke, the head of Old Mutual Investment Group’s MacroSolutions boutique, says investing in a unit trust fund enables you to diversify across a number of securities, such as shares, that are selected by a professional and experienced fund manager.
A unit trust fund also gives you the ability to liquidate your investments quickly, with funds typically paying out within 48 hours – and the costs are reasonably transparent.
You can invest in a rand-denominated fund that, in turn, invests in foreign markets, or you can invest directly in a fund domiciled offshore and denominated in a foreign currency.
However, a rand-denominated fund saves you from complying with exchange control regulations and converting your money into a foreign currency via an offshore bank account.
You can also build your own share portfolio using a stockbroker or the private-client services of a financial institution, and either select the shares yourself or give the stockbroker the discretion to choose shares for you.
However, you should be aware that, in addition to the exchange control requirements, you may incur capital gains tax (CGT) on the sale of each share within the portfolio.
With a unit trust fund – denominated in rands or in a foreign currency – you pay CGT only when you realise your investment in the fund.
When it comes to unit trust funds, your choice includes pure equity funds that invest in financial markets globally and multi-asset funds that invest across asset classes in different countries.
Old Mutual’s rand-denominated Global Equity Fund recently won the Raging Bull Award for the best global equity fund over three years to December last year. Over that period, it produced an annual average return of 40.98 percent in rand terms – well above the MSCI World Index’s 31.6 percent.
The fund invests in the same shares that make up the MSCI World Index, but takes small bets to increase or decrease the weighting of those shares in the portfolio. It is guided by five investment strategies to identify shares that, in the fund manager’s view, are mispriced (the price is not a true reflection of the share’s inherent value).
Old Mutual also has a rand-denominated multi-asset fund, the International Growth Fund of Funds, which invests in a number of Old Mutual International’s offshore funds. This fund was the top performer in the global multi-asset flexible sub-category over one, three, five and seven years to the end of December last year. Over five years, it had an average return of 24.78 percent a year.
Traditionally, investing offshore when the rand is weak, as it is now, has not delivered good returns for investors, Brooke says.
The risk to which your investment is exposed if you go offshore now is much higher than it was a year ago, when the rand was stronger, he says.
Only if the rand weakens further will investments made now deliver good rand returns.
If the government makes policy mistakes, the currency will weaken further, Brooke says. But if the government commits to the National Development Plan and delivers an austere budget with less spending, the rand may strengthen, he adds.
Given these risks, you may want to consider a fund such as the Old Mutual Maximum Return Fund, managed by Brooke, which holds a higher allocation to both international assets and equities than is permitted in terms of regulation 28 of the Pension Funds Act.
However, with these kinds of funds – classified as worldwide funds – the manager decides when will be a good time to have a higher exposure to offshore markets and when it is better to have high weighting to local shares.
You have thousands of funds from which to choose if you want to invest in a fund denominated in a foreign currency and domiciled in a foreign country, but, for peace of mind, you should choose a fund that the Financial Services Board (FSB) has approved for South African investors.
An FSB-approved fund will be domiciled in a country that has unit trust fund regulation similar to that in South Africa. The fund must have an office or person in South Africa who you can contact if you have problems with the administration of your investment.
‘EQUITIES ARE THE PLACE TO BE’
If you do invest offshore, you should invest in equities, rather than cash or bonds, Peter Brooke, the head of Old Mutual Investment Group’s MacroSolutions boutique, says.
Brooke strongly advises against investing in cash, because real (after-inflation) interest rates are negative in the 19 countries that fall under the European Central Bank and in Japan, Switzerland and Denmark. Economic growth and inflation in these countries is likely to remain low, so interest rates will also be low.
Bonds in many foreign countries are also offering very low returns. Yields – the interest earned relative to the price at which a bond is trading – on short-dated bonds with a maturity of between one and five years are largely negative.
Yields on 10-year bonds in Europe are about 0.2 percent, 1.7 percent in the United States and zero in Japan.
Brooke says if offshore equities achieve a bit of growth in earnings, they can deliver a nominal return of five to six percent, which is attractive relative to cash and bonds.
Equities are, therefore, the preferred asset class for international exposure, because in almost all markets the dividend yields on equities, as represented by major indices, are typically above those on cash and bonds.