Re-visiting the case for offshore investing
By Rowan Williams-Short, Chief Investment Officer, Nedgroup Investment Advisors (UK)
We are often asked to make the case for South Africans to invest offshore. A much more difficult proposition would be to make the case for not investing offshore.
South Africa has enjoyed a long spell of economic growth, vibrancy within certain sectors, a post apartheid dividend and the rewards of stoic monetary and fiscal policy. These facts have not escaped the attention of the markets. In this millennium, bonds have returned an annualised 14% and equities 18.5%, thus both providing handsome real returns. Sadly, past performance cannot be bought and the relevant but somewhat elusive issue is whether these performances have rendered market valuations unattractive. Most common valuation indicators suggest that this is indeed the case. As an example, the price: earnings multiple of the JSE All Share Index relative to that of the S&P500 has re-rated in the past three years from around 30% to a current level of over 90%, the sharpest relative re-rating on record.
Notwithstanding these admirable achievements, both South Africaâ€™s GDP and its market capitalisation remain less than 1% of the respective global totals. It patently makes no sense to confine oneâ€™s investments to that small an arena. Constraints to an investment universe are mathematically assured of diminishing the potential risk adjusted return.
Unfortunately the question of whether or not to invest offshore tends to arise as a tactical or a market timing issue, when it should be a strategic or long term consideration. Reasons for investing offshore that already have and will continue to enjoy longevity include:
* Diversification is the first principle of sound investing; it reduces political, currency, interest rate and many other idiosyncratic risks.
* It permits exposure to industries, which are not listed in South Africa.
* South Africaâ€™s equity market is inherently more volatile than Wall Street and other developed markets. The long term average rolling 12 month volatility of the JSE is about 19% against 12% for the S&P500 and 15% for the FTSE100.
* South Africa has a very open economy (measured by imports plus exports as a percentage of GDP). This does mean that the rand is susceptible to episodic weakness. Successfully predicting the onset of these sporadic episodes has proven to be beyond the capabilities of economists and investment strategists.
It has also been suggested that investing offshore is unpatriotic. In fact, that belief is rather xenophobic; it does not hold sway in most other countries, whose citizens would take offence at the suggestion that they are less patriotic than South Africans. Even in the USA, which offers the worldâ€™s broadest investment opportunity set (not only more equity and bond sectors but whole other asset classes such as mezzanine finance, convertible bond arbitrage, distressed debt, credit default swaps and many more) pension funds invest an average of 15% of equity holdings outside the USA. In countries with narrower investment choices, that percentage tends to rise considerably. Examples include Canada (51%), Japan (40%) and the UK (36%)1. The fiduciary duties of trustees and advisors require them to diversify and to protect investments. Lowering risk by investing offshore is one self-evident route towards those goals and if it helps to secure improved future wealth and financial stability for South African investors, then that is perfectly patriotically minded.
A topical issue (again) is the allegedly alluring case for investing in emerging markets. Returning to South Africaâ€™s market capitalisation share of the globe at less than 1%, it needs to be observed that emerging markets cumulatively account for about 10%. It is simply not prudent to allocate from that 1% into the other 9% with which it is most correlated rather than into the 90% with which it is, for good reasons, less correlated. Worse, the correlations between emerging markets have a pernicious habit of spiking towards 100% at exactly the most unfortunate times, namely in sharp bear markets. The current intrigue of China and India particularly seems to have caused widespread amnesia about this phenomenon and considerable confusion between grass roots economic development and sound investment prospects. In addition, the advent of new acronyms and nicknames (presently Chindia, and BRICKs and in past years such fashions as Nifty Fifty, TMT, Y2K, Asian, Celtic and Arctic tigers) should be treated with great circumspection. The launch by avaricious asset managers of funds bearing these names also tends to be a harbinger of calamity. (Remember the sad outcome of a fund that cunningly played its name on the theme of â€œwwwâ€?) And, as has been well documented, when these catch phrases roll off the tongues of oneâ€™s barber or taxi driver, the end is invariably nigh. We should be thankful for one of the stock marketâ€™s more dependable leading indicators.
Finally, it is being widely suggested to South Africans that investing abroad is unnecessary or obsolete given that some local funds and listed companies have international exposure. Dealing firstly with the funds, unsurprisingly these claims are made most vocally by purveyors of funds purporting to offer this facet. What they are actually offering is a sliver of exposure and expertise into the vast arena of global investments. Local fund managers cannot be experts in all world markets, some of which require very different skill sets, for example, wading through the maze and multitude of Japanese small caps. Turning to companies, corporate South Africa has some world-leading skills such as deep level mining and some enterprises with significant global market penetration, such as cigarettes, beer and luxury goods. Other peculiar pockets of endeavour such as heart transplant techniques, automotive glass and automatic pool cleaners have made their marks globally but the truth is that most local companies have not exactly covered themselves in glory in their global aspirations. For example, Australia is littered with the corpses of failed South African retailers, including several with impeccable domestic records. There is no need for us to berate ourselves about this; many countriesâ€™ companies struggle abroad because business models do not readily migrate into new cultures and regulatory regimes. British financial services companies have mostly had a miserable experience of trying to expand into the USA. American car manufacturers were infamously flabbergasted by their failure to sell into the Japanese market. (That they overlooked the understandable preference to have the steering wheel on the right when driving on the left did not help). Where listed South African companies do have significant portions of earnings emanating from abroad, the sources of these earnings invariably arise from the same sector as those companiesâ€™ domestic earnings, thereby negating one of the main premises for investing internationally, namely exposure to industries that are not domestically investable.
In summary, diversification into developed markets makes perennial sense, it is definitely not unpatriotic, it is best achieved via funds managed by experts in the areas where the assets are invested rather than by domestic managers analysing foreign markets as a part-time occupation, it cannot be satisfactorily attained or exploited via domestic companies with a portion of foreign earnings and the tactical case for doing so now (after extraordinary strength in South African markets) appears to be sound.
1Source: MSCI, Watson Wyatt and Bernstein Value Equities
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