Moving your finances offshore should not be the response to short-term changes in the local environment or a sudden rand depreciation. However, many South Africans have a history of reacting emotionally and moving funds offshore upon the rand depreciating significantly, therefore often leading to subsequent investment losses.
Instead, your own investment objectives and how best to attain them in a longer-term financial plan should drive offshore exposure. In general terms, it has been shown to be useful to nearly all long-term investors to include some international exposure in a portfolio. The below points are some of the main advantages of offshore investment.
Diversifying helps optimise your portfolio
Diversification across nations, sectors and businesses, as well as asset classes and currencies, is the main advantage of offshore investment. It decreases the risk of a portfolio for the same expected rate of return, resulting in a more “optimal” portfolio by diffusing the risk over many different investments. Simultaneously, offshore equity helps to minimise the risk characteristic in the local equity market, which is among the world’s most concentrated: between 2005-2012 the resources sector made up over 30% of the FTSE/JSE Top 40 Index, rising to over 45% at the peak of the resources cycle in 2008. Today the IT giant Naspers makes up more than 20% of the Top 40 Index.
Gaining exposure to growth opportunities
The stocks listed on the JSE make up only 1% of the world’s total listed equity market capitalisation. Therefore, if you only invest in South African equities you will miss out on 99% of the global equity universe. There are many under-represented fast-growing industries listed on the local exchange like pharmaceuticals, bio-technology and alternative energy. In addition, there are a whole host of many world-class firms to invest in.
Living in an emerging market such as South Africa and diversifying into developed markets often driven by various macro variables, can provide more stable growth, and provide exposure to a broad variety of industries in hard-currency, which can be greatly beneficial. At the same time, emerging markets that are rapidly expanding such as some Asian economies also offer profitable opportunities of growth, offering your portfolio a greater likelihood of yielding better returns than those limited to the domestic market.
Helping you reach your offshore goals
If you spend a large amount of time outside the country, or buy lots of imported goods, or if you wish to retire overseas or send your kids to schools outside South Africa, higher-than-average offshore exposure could be indispensable. Investments in hard currencies such as US dollars, euros, sterling and yen serve as protection against a depreciating rand (which is expected to continue into the long-term given the higher inflation rate in South Africa’s compared against developed markets), and other risks specific to South Africa. This essentially ensures you match longer-term offshore “liabilities” with equivalent assets.
At the same time, using offshore investments to speculate on currency movements (a notoriously hard task) is not advisable, but rather it would be better to have a globally diverse portfolio.
Acting as a safehaven
Having a portion of an investment portfolio offshore helps lessen the associated investment risks for those who are concerned about political or social instability in South Africa. In addition, it can help ease the worries of investors, make them more likely to stay invested in the longer term and avoid panic selling investments at the wrong time. However, feeling/emotional-based investing should generally be avoided: you should rather follow sound investment principles and a long-term plan to decide whether, when and how much to invest offshore.
How much should you invest offshore?
Your exposure offshore is highly dependent on your long-term investment objectives. Generally speaking, the offshore percentage of your portfolio will be larger the higher your targeted return on investment (and hence the greater the risk required). For instance, if you have a return target of inflation which is more aggressive +7%, you would likely need between 35%-40% offshore. Meanwhile, an inflation return target of+6%, is more in line with a typical “balanced” fund with an offshore percentage of about 30%. Lastly, a more conservative inflation target of +2%-3% would usually dictate offshore exposure of just 10%-20%. However, these are only guidelines and the exact proportion should be suited to your own long-term requirements.
Keep in mind that Regulation 28 of the Pension Funds Act only allows 25% (excluding Africa) maximum offshore exposure, plus an additional 5% in Africa (outside South Africa) for retirement approved funds. However, investors holding SA equities are also gaining exposure offshore through local firms with offshore operations: over 50% of JSE-listed companies revenue comes from outside South Africa. Thus Regulation 28-compliant funds are likely to have more than the allowed 25% (+5% Africa) effective offshore exposure.