Offshore on the agenda of SA managers

In recent months offshore as an investment theme has featured strongly on the agenda of numerous SA investment managers. Compelling arguments have been made for offshore investing with the most significant from a valuation perspective. In essence, it is w

Nonetheless even the most convincing argument for offshore investing may leave many an investor unconvinced. Severe losses suffered or a lack of return from offshore investments has resulted in a lost decade for many South African investors. One might therefore appreciate an investor’s decision to select an onshore investment at the expense of a good investment opportunity offshore.

However, even if an onshore investment is selected investors might not necessarily get what they expect. It’s become more prevalent for onshore funds to be managed with a far greater offshore exposure than in the past and investors seem to be unaware of this trend.

What has been driving this trend?

Offshore has been a strategic focus for several South African managers over the past few years and it’s been particularly evident in the way they have reinforced their offshore capabilities. Some managers have expanded their offshore teams, while other managers have selected to partner with an offshore based fund manager instead. This shouldn’t come as a surprise given the strong investment case for offshore equities.

The relaxation of foreign exchange limitations, from 15% to 25%, in recent years has also contributed considerably to this trend. In essence, a fund manager now has the ability to invest up to 25% of pre-retirement money in offshore assets as permitted by Regulation 28 of the Pension Funds Act.

Investors have also been beneficiaries of a significant number of ballot requests. Fund managers have been requesting investors to vote for the inclusion of offshore in the mandate of funds that did not previously make provision for offshore.

Evidence therefore suggests that onshore funds are bound to have a greater portion invested offshore. It is therefore critical that investors understand the drivers of return of the offshore component given the pronounced impact it can have on the performance of an onshore portfolio.

There are typically two drivers of return. Firstly, the performance of the underlying asset class i.e. offshore equities, which is the most obvious one. Secondly, the movement of the rand that often causes confusion amongst investors.

A simplistic example will be used to illustrate this concept. If a South African investor were invested in the MSCI AC World index (USD) during 2011, the underlying asset class (offshore equities) would have returned a loss of 10% (ex-dividends) for the year. The rand on the other hand depreciated significantly (between 18-22%) against the major currencies in 2011, which would have contributed positively to performance. The effect is a 10% positive return in the pocket of an SA investor as the extreme weakness of the rand negated the poor performance from offshore equities.

If one considers the performance drivers in 2011, offshore equities and bonds would have contributed significantly to the performance of a balanced onshore portfolio. The outperformance relative to local asset classes can mainly be attributed to the extreme weakness of the rand as risk aversion returned to global markets in the latter part of 2011. The converse is however also true where a particularly strong rand, as in 2010, will detract from the performance of the underlying offshore asset class.

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Source: MoneyMate (includes dividends)

Whilst the arguments for offshore investing are compelling and the benefits are considerable, in practice it’s often found that investors are not benefiting from this trend. The flexibility of choice combined with a misconception of the drivers of performance within a fund, unfortunately often lead to poor decisions that destroy value. Investors essentially chase performance by switching out of underperforming funds and into the top performing ones without reasons to substantiate their decisions.

For instance, even though offshore has been a strong driver of performance in 2011 this was not the case in 2010 or 2009. Investor behaviour shows that in 2010 several investors unknowingly switched out of funds with a large exposure to offshore assets - due to underperformance relative to peers - and into better performing funds which contained limited offshore assets. In essence, they destroyed value based on poor decisions.

The strategy of some fund managers will incorporate offshore investing to a greater extent than others, while a selected few are still firm believers in pure onshore portfolios. Investors are therefore urged to find a suitable strategy that meets their objectives. If one understands the context in which your fund performs, you are bound to make better investment decisions and will be able to capitalise on good investment opportunities.