Risks that come with global exposure

Gyongyi King, Chief Investment Officer at Alexander Forbes Investments

Market liberalisation is facilitating more varied portfolios through increased exposure to foreign assets.

The average foreign exposure from 2017 to 2018 across Latin America, the Middle East, Africa and Asia increased from 45% to 49% according to the Growth Markets Asset Allocation Trends: Evolving Landscape report released by Mercer, Alexander Forbes’s global partner. There have been even more pronounced movements in fixed income, where foreign exposure moved from 16% to 23%, with more relaxed regulations in some markets supporting this shift.

In South Africa, the Alexander Forbes Global Manager Watch™ Survey observed that portfolios increased their:
• allocations to growth assets over the measurement period
• holdings of foreign equity at the expense of domestic equity

This shift was made possible by relaxed regulatory restrictions limiting offshore investments, which recently increased from 25% to 30%, with a further 10% available for investment in Africa.

“Global investors are faced with the same concerns as South African investors – namely currency volatility, low growth, low returns, risk management – which require them to seek out the best investment opportunities,” said Gyongyi King, Chief Investment Officer at Alexander Forbes Investments. “As investors diversify their portfolios globally, they need to assess their risk.”

King highlights some of these risks and stresses the importance of active risk management:

1. Climate change risk
Climate change is of growing and significant importance to investors globally. The social, environment and economic risk posed by climate change have long-term ramifications, including investments. The causes need to be addressed timeously to avoid a spiral in treacherous temperature levels.

Climate change will have an inevitable impact on investment returns, and investors need to consider it as an important factor when considering future return drivers. Asset class returns could be materially influenced by the various climate change scenarios, and growth assets may possibly be more sensitive to climate risks than defensive assets. There are structural changes across all industries during the move to a low-carbon economy. Investors need to be prepared for these changes both at environmental and industry levels.

For example, oil companies have been key contributors to global emissions for many decades, yet virtually every global index fund has exposure to these shares. It is therefore questionable whether such companies have the correct valuations in recent years. We need to work towards developing appropriate policies to help reduce the risks of associated human-made climate change.

2. Currency risk
Currency risk can be multi-faceted and has a different meaning for different investors. The key features for investors include portfolio volatility, downside risk, exchange rate movement risk, individual asset class volatility and unfavourable hedge predictions.

In emerging markets, we are accustomed to currency volatility. But in more developed nations, currencies as assumed to be much more stable. In more recent years, however, some assumptions have been tested and currencies have experienced increased levels of volatility.

The British pound is an example of a currency experiencing increased volatility due to the withdrawal of the United Kingdom from the European Union (Brexit). With increased currency volatility comes an increasing risk on investments, and it is important that we start formulating new ways of assessing currency risk to meet changing needs.

3. China and emerging market risk
Emerging market investments are often considered with increased risk variables which are factored into investors’ return assumptions. Political change can often be assumed to be the main factor contributing to different risk profiles across emerging markets but this isn’t always the case. Structural changes can occur.

The increasing significance of China is arguably creating one of these structural changes as it takes up an increasing larger share of world equity indices. China has the second largest economy in the world and is continuing to grow. From an investment perspective, the market has only just started to open to foreign investors but this brings with it challenges. Understanding the rapid expansion in debt many investors worried about potential credit bubbles and other risk that need to be monitored. The International Monetary Fund, for instance, has warned that China needs to reduce country debt dependence and strengthen the financial sector regulation to reduce risk.

To deliver attractive risk-adjusted returns, King suggests that investors diversify investments by including alternative assets, diversified sectors and geographic broadening. Furthermore, as corporate sustainable leaders, we need to continuously be seeking sustainable ways of investing and structuring our organisations to address a range of key drivers, such as risk reduction, ESG, and brand appeal.