This is a good time to rethink your portfolio's offshore component

Time of article published May 16, 2004

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With the rand still at respectable levels, the general election behind us and the United States well into an economic upswing, this is a good time to have another look at investing internationally and at portfolio theory.

Investing a portion of your portfolio overseas has many advantages.

Firstly, it provides a natural hedge for any foreign exchange liabilities. Your children may wish to attend an overseas university or have an "overseas experience". Or you may be fond of international travel. The costs of travel are still prohibitive, even at current exchange rates, and if the rand resumes its long-term downward trend, these costs will skyrocket. Some sort of "insurance" is critical in this context.

Strong trends are hard to break and newcomers to the market may have already forgotten the past periods of rand weakness. But nothing moves in one direction forever.

Another advantage of investing overseas is the natural effect of portfolio diversification on the volatility of return. Having a mix of currencies as well as local and overseas equities provides a dramatic reduction in volatility when measured over the entire portfolio.

Modern portfolio theory explains how diversification allows for a higher possible return at a lower level of risk.

Investing overseas opens up a wider range of choice, because the ebb and flow of economic tides is different on foreign shores. For example, it was not too difficult to predict long-term US dollar weakness at least two years ago. Similarly, many international companies have a track record of long-term growth and a resultant positive performance of their share prices.

It seems a great pity to confine yourself to one economy and one stage of an economic cycle. According to The Economist magazine, the free flow of investment and labour would provide benefits to humanity 10 times those of scrapping all trade barriers and subsidies.

International investing seems dangerous and risky, and this may well be the case. However, investment theory remains a constant, because cash flow is cash flow and risk can be quantified in mathematical terms. Furthermore, the basic principles of good investing remain the same no matter whether a company is based in Geneva, New York or Sydney.

Another important point is the sustained strength of the rand. While it is difficult to predict when this trend will end, now cannot be a bad time to increase your overseas exposure. Clearly, overseas assets of almost any kind must be relatively cheap in rand terms. Money can always be returned during a period of rand weakness. This is also fine in theory, but easier said than done. Unfortunately, it always seems that the currency's movement is not in your favour when you need the money. And doesn't it always seem that you bought your foreign currency at exactly the worst time?

It is probably better to adopt a philosophical attitude about this and try to stick to a long-term plan. Whatever you do, keep it simple. A good rule of thumb is that if you don't understand an investment, don't touch it. The more complicated it is, the more difficult it becomes to predict the outcome.

The downfall of Long Term Capital Management illustrates my point well. Here was a hedge fund run by at least 10 investment experts, most with doctorates, who managed to make things so complicated that they did not predict an outcome. They were geared and lost all their capital - and a sizeable chunk of America's too. Alan Greenspan, the chairman of the Federal Reserve, had to intervene.

So, buy shares in sound companies that pay good dividends and sell real things to real people.

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