Investing offshore - What you need to know

Roné Swanepoel

From a broader set of investment opportunities to currency diversification, offshore investing can be a key strategy to help preserve and grow clients’ wealth over the long term.

Offshore investing could feel overwhelming and as an increasing number of investors inquire about investing offshore, we have included a quick overview to assist in these conversations.

The first and most important question is “Why do you want to invest offshore?”.

This question should be thought of from a long-term strategic asset allocation perspective. Investing offshore should not be done in reaction to negative news headlines and/or short-term market volatility, but rather form part of your holistic financial plan and wealth creation strategy.

What are some of the reasons to invest offshore?

• Diversification in different regions globally: South Africa makes up less than 1% of the global economy. Additionally, S.A. is facing a struggling fiscus, high unemployment rates and poor GDP growth. Investing offshore and diversifying one’s investment to include assets outside of South Africa, can offer protection against local market volatility and uncertainty.
• Broader opportunity set: Global markets offer a wide range of investment opportunities, especially developed markets. Investors can access more countries, asset classes and sectors that are often not available locally.
• Access to different currencies: Investing offshore offers investors the opportunity to grow their investments in foreign currency and payout in that currency upon withdrawal.
• Expenses that might need to be paid in a foreign currency in future: Some investors, for example, would like their children to study abroad, or buy a property overseas. For these investors, an offshore investment will make sense and provide a valuable vehicle to cover these expenses when it becomes due.

1. Currency and exchange rate considerations

Theoretically, exchange rates are determined by fundamentals, such as economic growth, inflation, and interest rates. Purchasing power parity, or PPP, is one of the most popular theories. It states that countries with higher inflation should see their currencies depreciate over time. But because not all currency participants are profit-seekers, exchange rates can deviate from their theoretical fair values.

Paying attention to currency valuation and the exchange rate is not unreasonable, as you naturally want more bang for your buck, but care should be taken to only focus on this. It may be useful to think about the currency as the hypothetical share price of the country.

With the above being said, the inherent currency risk when investing outside of South Africa is an important consideration when constructing portfolios with a wider global opportunity set. Currency can add volatility in the short term and some currencies can often trade at levels which differ meaningfully from fundamental fair value.

The rand has historically traded well outside its estimated PPP fair value with a relatively wide standard deviation of approximately 20%. The rand is shown to rarely trade in line with its fundamental fair value. This would suggest that it is nearly impossible to time the currency, as mean reversions to fundamental fair values occur relatively infrequently and over extended periods of time.

Furthermore, asset allocation explains around 90% of the variance in fund performance over time. So, choosing the right mix of assets to invest in and understanding their valuations are very important - alongside your tolerance for risk, and investment horizon.

2. Direct offshore investing versus using an asset swap/feeder fund

What’s the difference?:

• A direct offshore investment is an investment in foreign currency made within an investor’s offshore allowance (as set by the South African Revenue Service – SARS). This can be done by investing in an offshore discretionary or endowment/sinking fund investment vehicle (such as a unit trust fund, a fund of funds and/or a model portfolio).
• An asset swap investment invests in an offshore fund in Rands. In an asset swap investment, you use a third party’s offshore allowance. Your investment is essentially placed into a local fund (also known as a feeder fund) and converted by the management company (Manco) into foreign currency. They then use this foreign currency to buy into a global hard currency fund. This can be used in most products.

So what’s the pros and cons of using either strategy:

We strongly urge investors to consult their financial adviser at the outset of this journey, as your adviser would be best placed to assist with creating a suitable risk profile as well as recommend the different options that are available and best suited to your unique needs.

The world of investments is complex, with each of the different products on offer, having a different set of rules, fees and tax implications. In the following article “The danger of letting investment vehicles drive your investment journey” we highlight key factors to consider as to why you are investing and what to keep in mind when looking for a suitable product.

3. The importance of investing with a trusted global Investment Manager

As mentioned above, the correct asset allocation mix is of great importance when investing offshore. Therefore, the next consideration should be which investment manager to choose to invest with. Investors should seek a trusted investment manager with a proven track record, that provides a well-diversified and well-researched asset allocation underpinned by a solid investment process and, ideally, low fees.

At Morningstar Investment Management we have been managing clients’ money globally for three decades. We have operations in 31 countries with more than 400 investment and research professionals worldwide. The Morningstar Investment Management team unites the strengths of Morningstar Inc. and draws on both local and global research, data and analysis.

We use a valuation-driven investment process when constructing model portfolios. Valuation-driven investing is built on two key concepts. First, an asset has a fair value that can be estimated through careful analysis. Second, while the price of an asset may deviate significantly from fair value in the short term, it will tend to return to its fair value over the long term. Valuation-driven investing aims to earn superior returns by seeking out assets that are underpriced by the wider market and waiting for them to return to fair value.

From there, Morningstar’s global team of portfolio managers and researchers work together to holistically build asset allocation solutions suited to each strategy we offer. We seek to gain the largest exposure to our best ideas that are most underpriced, while building robust asset allocations designed to stand up to challenging investment environments. Each portfolio is designed to use active management where it may add the most value, taking into account an established risk level while minimising expenses.

Morningstar Investment Management S.A. offers three Global USD Funds and two GBP Model Portfolios available for South African financial advisers and their investors. Read more about our Morningstar USD Global Fund range on our website.

In closing

In today's uncertain global landscape, investors often experience apprehension when assessing their offshore exposure within their investment portfolios.

Amidst this uncertainty, the four factors within your control include –
1. Understanding why you want to invest offshore
2. Selecting the right investment manager with a fundamental, long-term investment approach. This approach prioritizes the development of resilient, comprehensive portfolios that align seamlessly with investor objectives.
3. Making informed decisions about the strategy used to gain offshore exposure - whether through direct offshore investments or via an asset swap.
4. Lastly, when opting for direct offshore investment, careful consideration of which product to use is crucial to attaining your offshore investment goals.