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Investment Strategy
Friday, June 26, 2015 - 02:16
Weak protection

When the rand weakens to levels not seen for years, like it has over the past few months, clients/investors often start to ask whether they should send more of their hard earned investments offshore, to protect from further weakness. This is especially true if backed by political turbulence (as experienced last week). The chart below shows the ZAR/USD exchange rate over the past 30 years, we are now near the lows of 2001.

“It is interesting to note that despite the continued rand weakness since mid-2011 the rand is still some way off, when adjusting the currency for the difference in inflation between South Africa and the US, to the levels that we saw in 2001 and 2008,” observes Mike Browne of Seed Investments.
Economic theory dictates that a currency should depreciate relative to another currency if the country experiences higher inflation, known as Purchasing Power Parity, in order for it to remain at ‘fair value’. As South Africa has higher inflation than the US, it is normal for the currency to gradually weaken versus the USD over time. The second chart shows the ZAR vs the USD and the fair value exchange rate over the past 30 years. Note that we are currently on the cusp of being 1
standard deviation away from fair value, compared to 2001 and 2008 when we exceeded this level.

At the height of the currency panic, ending in 2001, many investors took their capital offshore and invested into developed equities. This, on the basis that developed market stock exchanges (the US in particular) had done extremely well in the 90’s and also that the rand was a ‘one way bet’. “It is scary to note that some 13 years later an investor that made this decision has still not recouped his capital in real terms (inflation adjusted),” says Browne; “is some way off cash returns and has been left in the dust when compared to local equity (all adjusted for currency movements).” Chart three shows the performance of various assets over this period.

“It is always best for investors to remain rational and invest looking forward, rather than based on what’s happened in the rear view mirror,” he says. In this regard Seed, and most South African asset managers, have been overweight in global assets for the last few years to take advantage of the possibility of the currency moving from a strong to weak level, based partially on the fact that the rand was relatively too strong.
“It is important to note that we are unable to predict the future, and therefore spend little time looking into crystal balls,” says Browne. “We rather spend our time looking at valuations and assessing probabilities of investment outcomes based on the current information at hand. We then build diversified portfolios that are able to withstand the eventuality of multiple scenarios. It is also important to note that there are differences when compared to the end of 2001, mainly that global equities currently offer much better prospects of returns, due to better valuations when compared to the height of the Tech Bubble.”
Seed Funds remain overweight global assets, but we are close to the point where the risks of significant currency strengthening outweigh the risks of a currency blow out. As/if we reach this point our Funds will be incrementally adjusted to take advantage of the opportunity presented (i.e. repatriating investments, or hedging out currency exposure). We believe that investing is a probability vocation; in this regard we continually seek to get the odds in our favour and size our investments appropriately.

Copyright © Insurance Times and Investments® Vol:28.6 1st June, 2015
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