Offshore investments: Still the smart switch?

If history is anything to go by, switching from local equities to global equities might not be a smart move, since the correlation of the two asset classes over time is significant. However, the relative value of offshore equities and the strong rand curr

Whenever one considers diversification, one needs to consider why the diversification is necessary. In investment speak, the objective of diversification is to enhance the risk return profile of a portfolio.

To put it very simply, one wants to achieve the same or better investment performance with a lower risk budget. To achieve this goal, one normally needs to include assets that behave differently to those assets that currently populate the portfolio. A good diversifier for local portfolios is global bonds.

An investment view

However, one needs to add an investment view to what is arguably a theoretical argument. There are two factors that determine the total returns of an offshore investment in local currency, provided the investor does not hedge the currency exposure. Firstly, it is the performance of the offshore asset in foreign currency and, secondly, it is the change in the exchange rate when the foreign performance is converted back to local currency.

Offshore asset performance

Currently, the valuation of offshore equities, in general, can best be described as fair. Developed equities in particular have de-rated significantly from their lofty levels at the turn of the century.

On a price-to-earnings basis the bulk of the markets are trading on low double-digit multiples based on one year forward earnings which is in many cases more than 50% cheaper compared to 10 years ago. South African equities also trade on very similar multiples. However, ten years ago local shares were trading at similar multiples. In short, the significant valuation gap between local shares and its offshore peers has closed. Hence, purely from a value perspective one can justify an increased offshore equity exposure.

Of course, one can add the argument that the inclusion of well-known world-class equities at a reasonable price will enhance the quality of the portfolio.

Exchange rate

Then there is the issue of the value of the rand. The recent strength of our currency has surprised many commentators. While we acknowledge the risk of forecasting the rand, our view is that the rand is currently overvalued on a purchasing power parity basis. Ten years ago the rand was very cheap on this basis. An overvalued currency provides an opportunity to buy “more” offshore assets.

Smart switch

We believe that both the relative value of offshore equities and the strong rand provides a good opportunity to switch from local equities to global equities, acknowledging that it remains a risky asset class.