Given South Africa’s abysmal economic performance and years of anaemic market returns, negative sentiment has sent local investors sprinting for the greener pastures of offshore equities.
While regulation 28 of the Pension Funds Act limits the offshore exposure of retirement funds to a maximum of 30%, a question frequently raised by investors is: Does South African equity have any place in discretionary savings portfolios? The answer is that although, in our view, global equity represents a more attractive “buy” prospect than local, this does not mean that you should sell out of South African equity.
It’s true that global markets have significantly outperformed the JSE over the past 10 years.
However, this was largely the result of a surge in strength from the US. In fact, a closer examination of the MSCI All Country World Index, excluding the US, reveals that global market returns were largely in line with the JSE’s returns in dollar terms.
Moreover, the narrative that poor economic performance in South Africa has caused the JSE to underperform substantially is false. Measured in dollar terms, the JSE’s performance over the past decade is virtually indistinguishable from emerging markets and Europe, even though many of those regions fared far better economically.
It is important to note that the JSE is home to world-class international companies. Some 71% of the JSE Top 40’s earnings are derived outside South Africa, and in particular the east and China as a result of exposure to Tencent and commodities, which is why the JSE’s movements are often in line with non-US stock exchanges.
Cyclical relative performance
The most compelling argument for South African equity as part of a long-term investment strategy, however, lies in a comparison of the JSE’s historical performance with the US market.
History reveals that the JSE’s recent period of underperformance relative to the US is not a new or once-in-a-lifetime occurrence. In fact, it is the norm rather than the exception, as the South African market regularly goes through cycles of outperforming and then underperforming the US (see graph).
In 1998, for instance, hot on the heels of the emerging market crisis, a bleak economy and poor returns, particularly compared to the US, also saw a number of South Africans disinvest from the JSE and move funds offshore - despite an unattractive rand exchange and poor global stock market valuation levels.
But soon after that, the early 2000s saw the beginnings of what is commonly referred to in the US as “the lost decade”.
The turn of the millennium saw US markets reach the height of the dotcom bubble and then subsequently crash, followed just a few years later by the Great Recession.
Together, these meant that the US had one of its worst decades in memory.
And unfortunately, all those who had disinvested missed out on what would eventually prove to be an amazing decade for the South African equity market, which produced some of its strongest real returns on record.
That said, equities are long-term investments and, far from advocating that investors should choose South Africa over the US, evidence further shows that a combination of South African and US equities has historically delivered a superior outcome from a risk and a return perspective than either alone.
In the nearly 60 years between 1960 and last year, South African markets delivered real returns of 8% with a standard deviation rate (which is used to measure volatility) of 20%.
Also measured in rand terms, US markets over the same period delivered real returns of 7% with a standard deviation rate of 17%.
But investors who opted for a 50/50 combination of both would have seen the best results, achieving real returns of 8% with a standard deviation of only 15%.
This suggests that, from a strategic portfolio construction perspective, the contracyclical properties of South African and US markets can be used to ameliorate risk and enhance investment returns.
Harold Strydom is an investment strategist and portfolio manager at Citadel.