The case for more global diversification

Adriaan Pask, Chief Investment Officer at PSG Wealth.

It seems that most investors are currently kept awake at night due to the high level of uncertainty regarding the future of South Africa. This makes sense given the volatile sovereign environment, weak economic indicators and the prevailing negative consumer and business sentiment. Given these concerns many investors feel the need to move their money offshore. However, these factors are based largely on emotion and one of the key requirements to be a successful investor is to remove emotions from your investment decision-making framework.

Removing emotion from investments

When investing offshore, investors should be doing so not because of a specific view of the rand (views that are often caused by sentiment driven by political turmoil), but rather for the diversification benefits it offers. Over the past two decades, consensus views on the rand have often been wrong, often spectacularly so.

Recent research from Charles Schwab, the US-based brokerage and banking company, revealed that investors tend to hold mostly domestic stocks – even when their country is the home of only a small portion of the world’s stock market. Similarly, South African investors seem to believe that they are sufficiently diversified when about 75% to 80% of their equity investments are held inside South Africa. However, the Johannesburg Stock Exchange (JSE) merely represents about 0.6% of the global equity market.

Investors forego the opportunity to gain access to growth regions that benefit from mega-drivers like industrialisation, urbanisation and growing consumerism when only investing in domestic markets. Additionally, diversifying offshore gives local investors access to industries that are not present in the South African market (e.g. information technology, electronics, pharmaceuticals). Investing offshore also provides a wider opportunity within industries because there are so many quality firms from which to choose.

Diversification is lacking – globally

An analysis of country level stock returns against the returns of global equity sectors indicates that no single country provides their local investors with full exposure in the global stock market. In fact, most investors would be surprised to know how closely stock markets even in major countries track the performance of a single sector in the global stock market. For example, in Japan the stock market closely tracks the global financial sector.

There’s no benefit in restricting your investments to one country. Even combining South African exposure with a selection of some of the major countries will likely not result in a fully diversified portfolio. Broader global diversification is required to gain access to full global market exposure.

Geographic location is increasingly less meaningful when it comes to investing. At one stage, all markets were largely domestic and the fortunes of companies largely depended on their local environment. But international trade now accounts for nearly two thirds of the world’s gross domestic product (GDP). According to the World Bank this is up from less than half that just 10 years ago, and one third about 30 years ago. The world has increasingly become one global marketplace for companies to operate within.

Investing offshore should be done for the right reasons

Diversification is the best reason and not because domestic political or economic conditions weaken the rand. Diversification can help lower portfolio volatility and ensure you always have some exposure to whatever sector is performing the best. Understandably, diversification can also seem to be a drag on portfolio performance when one sector sharply outperforms the others for an extended period.

Your precise levels of diversification depend on your risk tolerance and time horizon. Most investors can broaden their opportunity set and diversify their portfolios, simply by significantly boosting their international exposure.