Strategic Reasons To Invest Offshore - July 2016
Investors who restrict their universe to domestic assets miss out on 99% of the available opportunities presented by listed assets around the globe (see Figure 1). By diversifying your investment portfolio to include offshore assets, you gain access to growth regions that benefit from mega-drivers such as industrialisation, urbanisation and growing consumerism.
You also gain access to industries that are not present in South Africa (e.g. information technology, electronics, pharmaceuticals), in addition to a much wider opportunity set within industries. Our preferred global equity benchmark, the MSCI All Country World Index, currently comprises approximately 2 500 investable companies compared to roughly 100 that drive the returns of the local market.
>> FIGURE 1 RELATIVE SIZES OF WORLD STOCK MARKETS, END-2015
It is important to have a global mindset when allocating capital as stock markets in most countries tend to be dominated by a small number of industries. The Credit Suisse Global Investment Returns Yearbook 2015 stresses this need for global diversification across countries to effectively diversify across industries. Figure 2 illustrates the concentration of industries by country. Given the historic dominance of the US economy, it should not be surprising that many industries are dominated by the US. However, a US-only portfolio will miss out on industries such as real estate and leisure goods (dominated by Asian markets); alternative energy (Denmark and China); or mining (Australia and the UK). The implications are clear - investors in most countries will end up not optimising the available diversification benefits by restricting their investments to their own country. A final point for consideration is that the distribution of wealth in the world is changing fundamentally, with many emerging economies becoming increasingly sophisticated. This deepening of the opportunity set has the potential to create significant wealth for the patient investor prepared to invest in these economies through the inevitable setbacks incurred as they catch up with the developed world.
>> FIGURE 2 CONCENTRATION OF INDUSTRIES BY COUNTRY, START-2015
An offshore allocation provides the attractive feature of reducing the level of risk required to achieve a specific rate of expected return. Studies on optimal portfolios recommend a minimum offshore allocation of 20%−30% through the cycle for long-term investors requiring a return of inflation plus 4% to 5% in rand terms. This is the classic recommendation for retirement savers aiming to optimise outcomes for their future pension with which they would need to buy a basket of local goods and services. Investors with more diverse spending requirements, including a larger share of foreign currency denominated spending, or bequest motives (where multiple generations may live on different continents), can typically justify a larger offshore allocation. Whatever you decide your strategic allocation range to be, we believe that investors should still have an offshore allocation in line with their appropriate strategic weighting, given the elevated level of economic and political risks facing South Africa at present.
MATCH YOUR LIABILITIES
It is worthwhile to remember that many items in a consumer’s shopping basket (from fuel to food to healthcare) are largely priced in foreign currencies as the inputs are either commodities (with prices struck in global markets), or heavily reliant on imported content. Viewed from this perspective, having adequate offshore exposure is merely a hedge against the long-term change in price of this part of your future shopping basket. Episodes of currency weakness will more than likely remain a strong driver of price increases into the future.
DECIDING ON YOUR STRATEGIC ALLOCATION LEVEL
This is a question best answered through a comprehensive financial planning process with the assistance of a competent adviser. We can offer the following as generalised guidance:
- All investors can benefit from the portfolio optimisation benefits described above, making 20% the minimum suggested strategic offshore allocation for all long-term investors.
- Pensioners and other investors that need to fund a long-term rand income from their investment portfolio should guard against having too much offshore exposure as rand movements can be volatile. Income-funding portfolios should typically not have more than 35% in offshore equities.
- Wealthy investors, who don’t have immediate income requirements, have more latitude: up to 100% of their investment portfolios can be invested in offshore assets, depending on their objectives and tolerance for risk.