25 Aug Risk Management — Reasons for South Africans to Invest Offshore
Building up sufficient retirement savings is a long-term project that boils down to optimal risk management. The chief way to reduce your investment risk is to diversify your assets (across asset classes, markets and currencies) and this where investing offshore comes in for South Africans.
Investing offshore allows you to avoid linking all your outcomes to the performance of the South African economy and/or the JSE. It gives you access to different geographic regions, diverse economies, a broader selection of companies and industries and a greater number of fund managers with a variety of investment strategies.
So, what is the primary benefit of offshore investing?
In short, it increases your potential to earn positive investment returns even under difficult conditions. This is valuable given the current climate of relative economic uncertainty, globally.
With the market capitalisation of the entire JSE less than 1% of the world’s listed equity market capitalisation, remaining invested only in SA equities will result in forgoing 99% of the opportunities offered by the global equities market.
Compounding the narrowness of possibilities offered by the JSE is the fact that it is extremely concentrated and illiquid — for example, Naspers makes up around 20% of the entire JSE All Share Index and is in turn heavily invested in a single Chinese company, Ten Cent. All in all, it doesn’t allow you much scope to spread your risk.
There are also practical reasons to invest offshore
If you spend a reasonable amount of time outside of South Africa (either moving back and forth between a primary and secondary place of residence, or merely as an extensive traveller), you will be paying for goods and services directly in foreign currencies.
Similarly, one of the main constituents of the fuel price in South Africa is the dollar fuel price on world markets which is then multiplied by the USD/ZAR exchange rate. So depreciation of the Rand leads to a rising fuel price when you fill your car, which in turn has a direct impact on the agricultural sector, food and general goods’ prices through increased costs to transport products to retailers.
Finally, all imported goods such as cellphones, other technology and electronics are denominated in foreign currencies, so a depreciation of the value of the Rand results in paying increased prices for these goods as well.
All in all then, there is a solid case for having offshore investment exposure…
It allows you to match your offshore ‘liabilities’ with equivalent assets i.e. market movements of your investments have direct correlation to changes in the cost of goods and services you consume both within and beyond South Africa’s borders.
So, how does one go about it?
How to invest offshore from South Africa
Given our exchange control measures, there are two main avenues to gain offshore exposure: Rand-denominated investing (asset swaps/indirect offshore investing) or foreign-domiciled funds (direct offshore investing)
By investing in a Rand-denominated offshore unit trust, you invest in Rands but the Funds have mandates to invest in foreign assets. The unit trust management company converts the Rands into foreign currency and invests offshore using their foreign exchange capacity (offshore investment company allowance).
The returns on investment are reported in Rands and all withdrawals are made in Rands into your local bank account.
Capital gains is charged not only on the growth on the investment but also as on the change in investment value as a result of the changing exchange rate.
Direct offshore investing
By investing in a foreign-domiciled unit trust, the investor invests directly in offshore funds that are denominated in the offshore currency. The investor has to make use of their Single Discretionary Allowance to transfer the funds offshore and will have to convert the funds into foreign currency themselves.
The returns on investment are measured in the foreign currency and the investor has no obligation to bring the funds back into South Africa, the funds can be paid into any offshore bank account in the investor’s name.
Capital gains are only charged on the growth in the investment in foreign currency which results in a less tax to pay.
So now that you know the basic mechanisms, let’s look at the relative returns.
How do local equity returns measure up against those of offshore equities?
As always, past performance is not a predictor of future performance. In addition, we have just come through a year unlike any other in financial history. However, basic due diligence always requires that we examine the information to which we have access.
As you will see in the graph below, the South African equity market has outperformed the global equity market by a significant margin over the last 12 months ending May 2021, both in Rand and US Dollar terms.
On top of that the Rand has strengthened substantially during the last year, so the global equity return in South African Rand terms has suffered further as a result of that strengthening.
However, while South African equities currently seem a much better investment in terms of returns over the short-term, it is important to note that investing offshore is a long-term prospect, so as an investor you will likely be exposed to this asset class over at least a 5-year or 10-year period.
As seen below, on average over the last 5 years and 10 years, global equity has outperformed local equity in both South African Rand and US Dollar terms, with South African equity even returning a negative yield over a 10-year period in US Dollars.
So, should you be investing offshore?
At Netto there is no ‘one-size-fits-all’ answer to that question. Contact your Certified Financial Planner Professional (CFP) for input on how to assess the importance of offshore investment exposure for your specific investment portfolio. Your life stage, future plans and current retirement investments all have a bearing on how you answer that question.