It is an inescapable truth that offshore indices such as the S&P 500 trumped the JSE All Share index over the last decade, vindicating those who campaigned for a heavier offshore weighting.
The US dollar has appreciated 176% against the rand since 2000, which further explained the logic of moving funds offshore to protect against this relative withering of the rand (notwithstanding the recent strengthening of the rand).
“Had you kept your money in rands you would have earned a higher rate of interest than if you had invested US dollars at much lower interest rates,” says Craig Sher, head of research and development at Discovery Invest. “But those returns, measured in US dollars, start to look less attractive, considering the rand lost 23% against the US dollar over the last 12 months.”
Is offshore investing risky?
A core principle of investment is that higher returns come with higher risk. So, if offshore equities have beaten the JSE ALSI returns over the last decade, does this not expose investors to higher risk?
“One of the main reasons for investing offshore is diversification, which should reduce risk,” says Sher. “Investing globally gives diversification across currencies, sectors and geographies. If you are too focused on South African assets, you are exposed to rand-related risks, as well as a limited pool of investible assets.”
A traditional basket of SA goods including cell phones, clothes, transport, electricity, and fuel is influenced by the US dollar-rand exchange rate.
“When putting together an investment portfolio, you need to be able to match those liabilities,” adds Sher.
“South Africa represents only 1% of the global market and only 0.2% of global unicorns [privately held startups valued over $1 billion]. When investing, you need exposure to a broad range of quality investments that are often not available in SA – such as technology, logistics, health care, and energy. You have limited options to invest in these sectors in SA.
Efficient frontier
The efficient frontier is a theory developed by Nobel-prize-winning economist Harry Markowitz in the 1950s that explains how investors can optimise their portfolio returns within a given risk profile. At the one end of the risk spectrum, cash is perceived as low risk with low returns, while on the other end global equities offer higher volatility with high returns.
What this theory doesn’t show is that risk profiles change as the time horizon shifts.
“When you measure the risk-return profiles of assets over the short term, you can see cash as a low risk asset over say, one year,” says Sher. “On the same basis, global equities on a one-year time horizon are likely to be relatively volatile. But as you push out your investment term to seven, 10 or even 15 years, and measure risk as your chances of not meeting your long-term investment goals, you start to see that global equity investments become a much safer [strategy], and cash, by contrast becomes a ‘risker’ investment strategy.”
Cash investments over the longer term are unlikely to meet your long-term spending needs. Sher says the time horizon of investments changes the risk-return profile, making it more certain that investors who have a diversified portfolio including offshore investments, will be able to meet their saving objectives.
When to move funds offshore
A recurring pattern among South Africans is the tendency to move funds offshore after the rand has weakened substantially. This can have a material impact on returns, since the exchange rate determines the price paid for offshore assets.
There are times not to move funds offshore, such as when the rand depreciates suddenly and sharply.
The chart above shows a negative correlation between the US dollar-rand exchange rate and the S&P performance.
“Often we get so fixated on trying to time the rand, we forget all about the price of the global investment we are buying,” says Sher. “It might still be a good time to invest offshore even when the currency is weak.”
He points out that rand weakness is often not the result of South African domestic factors, but rather because of US dollar strength which may move in the opposite direction to US or other global markets.
The dangers of DIY investing
“It’s important to get advice on how to invest offshore and what the best and most efficient plans from a tax and estate planning point of view are,” adds Sher.
There are excellent ways of investing offshore. For example, a global endowment allows South Africans to take money offshore, invest in a range of fund managers and gain significant tax benefits at the same time.
The global endowment is becoming a popular way to invest offshore because you can access funds when needed with tax benefits that are often better than those available locally. Fees are competitive and the structure is particularly efficient from an estate planning point of view. There are also unique features that may be applicable; for example, the Discovery Global Endowment plan allows South African investors to take their money offshore below the prevailing market exchange rate and benefit immediately from the currency.