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Investment Strategy
Thursday, July 16, 2015 - 02:16
Exchange control opportunity

In Finance Minister Nhlanhla Nene’s February budget speech, he announced increased scope for South Africans to invest offshore, raising the foreign exchange allowance for individuals from R4 million to R10 million per calendar year. For many investors, R10 million could be a substantial portion of their investable portfolio.

How do you get offshore exposure?

Explains Andrew Mackie, Investment Analyst, Maitland, “There are two primary channels of investing offshore. The first is to invest via a local rand-denominated feeder fund that in turn invests in offshore assets. The advantage of this approach is that it does not require you to use your foreign-exchange allowance, which means it is not necessary to buy foreign currency or get a tax clearance from SARS (and is not affected by the comments in the budget speech). Whilst this option provides you with offshore exposure, your capital (and gains/income) must always be repatriated back into South Africa and redeemed into your local bank account.”
The second channel, he says, is to make use of your foreign exchange allowance and instead of just getting offshore exposure, your money is actually sent abroad in your own name and there is no requirement to repatriate funds back into South Africa. In order to move funds abroad you will require a tax clearance certificate from SARS (specifically for the purposes of investing offshore). Following receipt of this you are allowed to convert your rands into foreign currency using an authorised dealer and are then able to invest into foreign investments either directly or through an offshore custodian.

Why invest offshore?

Mackie says investing offshore provides access to a larger universe of investments than those available locally and that may have greater value and/or return prospects. The JSE is a highly concentrated exchange that is dominated by a few large-cap stocks and is resource-heavy relative to other equity markets. Global markets will provide opportunities in new and unique investments including industries not as well represented in SA such as technology and bio-tech stocks.
Allocating offshore introduces portfolio diversification so you are not entirely dependent on the success and behaviour of the SA market. This is especially relevant considering the political, economic and socio-economic risks present in the SA economy which represents a fraction of global markets.
Foreign-currency assets become more valuable in rand terms if the rand weakens and so act as a rand hedge. This also serves to reduce volatility especially in portfolios with local investments that are sensitive to rand weakness, such as importers or companies with foreign debt. Thus, global exposure is advantageous to local investors at a time when emerging market currencies are volatile and vulnerable to global factors outside their realm of control.

Have you missed the party?

“The advantage of global investing is that it complements a local portfolio - to invest solely in a global portfolio would be an extreme decision for any local investor, especially for someone who relies on their portfolio as a source of income to fund rand-denominated expenditure,” he notes.
Despite the much publicised concerns around South Africa (few of which are new), the JSE All Share Index (total return) has outperformed the MSCI World Index (a measure of global equity markets) in ZAR terms over almost every measurement period on a rolling 5-year basis since 2007 (data starts in 2002). The extent of outperformance has narrowed recently. “However, the good news is that investors who have up until now only invested locally would not have missed out relative to peers who had invested globally,” says Mackie.

See graph below.

Graph: JSE ALSI compared to global equity markets

Unless opting for an aggressive equity orientated portfolio, most investors are also likely to include an allocation to other asset classes in their portfolios. The local bond and cash markets offer compelling real yields (i.e. adjusted for local inflation) relative to global developed markets, and the argument to make such investments offshore is less compelling (see table below).

Table: Source: Bloomberg

While the case for the SA market has looked favourable, it would be unwise to turn a blind eye to the local market fundamentals and the domestic risks at hand. Mounting economic pressures with twin (budget and current account) deficits, high levels of unemployment and ailing power supply from Eskom contribute to discomfort amongst investors. These factors, combined with stretched valuations (a current JSE All Share P/E ratio of 21.12 relative to the 10 year average of 14.75), make local equities vulnerable to any international events that might trigger a ‘risk-off’ response, such as the first Fed rate hike.
These concerns together with currency risk support the need for an element of diversification via offshore investing, especially in equity markets. There would appear to be little opportunity cost today for an investor to take advantage of their increased foreign exchange allowance in order to introduce an element of diversification into their portfolios.

Copyright © Insurance Times and Investments® Vol:28.7 1st July, 2015
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