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Increasing returns or reducing risk

13 January 2022 Gareth Stokes

Portfolio diversification, hedging exposure to the volatile rand and avoiding the concentration risk in domestic financial markets are among the many reasons given by South African investors for taking some of their money offshore. Whatever the reason given, you can be sure your client’s overarching investment goal is to maximise return, minimise risk and, more recently, achieve these outcomes sustainably. “Anything an investor does in their investment strategy is aimed at either increasing returns or reducing risk,” said Nimisha Bhagwan, Head: Investment Advisory at Alexander Forbes Investments, during a presentation on global investing themes for 2022.

Plus sustainability makes three

Taking funds offshore enables local investors to tick both the risk and return check boxes while opening the door to a wider range of sustainable investment opportunities. The risk and return trade-offs in going offshore are plain to see… Firstly, investing offshore allows your clients to include a wide range of return drivers in their portfolios, including exposure to different geographies and investment themes. “Sectors like technology and utilities are either not available or totally underrepresented in the South African market; by going global, investors can access a broader opportunity set across asset classes and countries,” explained Bhagwan. 

Imagine, for example, that your client wanted equity market exposure to one of the emerging technology themes  such as automation, electric vehicles or multi-cancer screening. There are no locally listed shares that will give them this exposure, whereas there are dozens across Asia, Europe and the United States. Local investors with an appetite for technology stocks understand the JSE’s limitations all too well. While they appreciate Naspers for its exposure to China’s Tencent, they would much rather achieve diversified exposure through a basket of US-listed tech giants such as Amazon, Apple, Google, Microsoft and Netflix, to name a few. 

The wagon wheel that locals are missing

The dearth of theme-linked local investment opportunities is illustrated by a wagon wheel graph comparing South Africa’s listed company universe with that of the MSCI World Index, per theme. Whatever the theme, SA-focused investors were left with at most a handful of investible opportunities compared to the dozens or even hundreds of companies when going offshore. 

As mentioned in the opening paragraph, going offshore is also a great way to hedge your clients’ portfolios against exposure to the rand, which is among the most volatile currencies globally. “Going global helps investors to protect their investments against short-term currency moves that can be highly unpredictable,” Bhagwan said. And finally, investing offshore helps local investors to escape the concentration risk posed by a handful of local shares’ dominance on the various JSE indices. Naspers and Prosus make up about 13.5% of the JSE Top 40 index and nearer to 16.5% of the JSE All Share. 

Those who are locked into SA-focused portfolios need not despair, because they enjoy significant offshore protection thanks to the earnings ‘mix’ of JSE-listed firms. For example, 65% of the earnings of companies in the JSE All Share index actually come from offshore sources. Given the indirect global exposure that investors secure  through shareholdings in the local listed space, the next question becomes how much direct global exposure is optimal. Does the “everything must go” argument offered by many local asset managers hold water, or is there a more reasonable approach that works just as well? 

The ‘one size fits all’ offshore strategy myth

“Being an advice-led organisation, we recognise that there is no single right answer for all investors when it comes to deciding how much to invest offshore,” said Bhagwan. There are also regulatory restrictions that apply to certain investment products, most notably the offshore exposure limits imposed on South African retirement funds by regulation 28 of the Pension Funds Act. 

According to Alexander Forbes, most institutional investors in the retirement fund space are prepared to invest up to the maximum 30% offshore for their accumulation-focused portfolios, with only a handful getting close to the 10% additional allowance for Africa (excluding South Africa). The asset manager reckons that the sweet spot is around 30% offshore, and argues that those who invest more than 30% offshore may not generate additional return in line with the additional risk they take on. 

An individual’s post-retirement strategy will be heavily influenced by the amount of accumulated capital they have; the retirement structures they choose; the level of income required in retirement; and liability matching, among other factors. “Retail investors tend to invest in line with their liability profiles and risk appetites, with due consideration for their offshore investment allowances and any discretionary offshore exposure they may have through unit trust feeder funds,” said Bhagwan. 

There are countless financial instruments that help investors to get offshore exposure. Some prefer direct exposure, either through offshore managers or the global offerings of local managers. Each route has its pros and cons. “Local managers’ global options tend to be quite limited and can be expensive due to the resources needed to cover the exponentially bigger investible universe for a smaller portion of that manager’s total assets under management,” said Bhagwan. And investors might not be able to take advantage of emerging investment themes using this route. 

Beware the sliding fee trap!

There are many considerations when choosing an offshore investment vehicle, including the manager’s skill in a specific region; the manager’s investment strategies; and the manager’s prospects for outperforming its benchmark. Fees remain an important consideration too. One of the risks facing local investors who opt for the direct offshore route is that many funds operate a sliding fee scale based on the amount of US dollars invested, which means SA-domiciled investors often end up in the highest fee band. “You also need to be aware of any additional layers of fees that exist in so-called feeder funds,” said Bhagwan. 

Writer’s thoughts:
The challenge facing SA-focused equity managers and investors is highlighted by a recent Moneyweb.co.za article titled ‘Another flurry of de-listings hits the JSE’. And it must be increasingly difficult for active fund managers to stick to their investment methodologies as the investible universe shrinks. Are you concerned by the ongoing exodus of firms from the JSE? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].

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