The longer-term impact of COVID‑19 on financial advisor practices

COVID-19 has resulted in SA investors increasingly living and investing abroad. This presents both challenges and opportunities for SA advisors.

Jul 28, 2021

8 minutes

COVID-19 has resulted in SA investors increasingly living and investing abroad. This presents both challenges and opportunities for SA advisors.
The fast view:
  • It seems that many clients, faced with the COVID-19 market shocks and a series of lockdowns, were triggered to review their personal financial affairs with a specialist.
  • Some of the key developments that have emerged during these challenging times are the increased internationalisation of South African investors’ assets and an intense interest in emigration.
  • Advisors need to carefully weigh up the risks of currency volatility against portfolio returns before dramatically increasing offshore allocations.
  • In future, local advisors are increasingly going to have to deal with a wave of “non-resident investors”, and the implications of this should not be underestimated.
  • Taking advantage of this opportunity will demand new skills and expertise from financial advisors.

The sudden onset of COVID-19 in 2020 and the associated economic and investment market shocks impacted the way many South African investors view their financial situation and their future plans.

It seems that many clients, faced with an uncertain infectious disease and stuck at home in lockdown, were triggered to review their personal financial affairs with a specialist. The result of this was a spike in advisor-client conversations which focused on:

  • Estate plans in case of the unexpected death of a key provider in a family unit.
  • Investing idle assets that have been hiding away in cash due to poor SA stock market returns in the preceding five years.
  • The risk of prescribed assets for retirement funds and whether retirement fund tax benefits still outweigh the impact of Regulation 28 restrictions.
  • Relooking the offshore exposure in investment portfolios, partly in response to the rapid depreciation of the rand at the time.
  • Preparing a client’s estate for a possible emigration.
  • The implications of National Treasury’s abolition of the concept of an “emigration for exchange control purposes” and access to retirement funds on emigration.

Whilst it is by no means clear how each of these trends will play out, we believe that the last three developments regarding offshore investment exposure and emigration represent a step change for many advisor practices. Below we explore some thoughts about this change.

Increased offshore allocations within investment portfolios

The knee-jerk reaction of the South African investment community to allocate more assets offshore as the rand weakens, is nothing new. Therefore, general media complaints about Regulation 28 limits on offshore exposure for retirement funds came as no surprise. Nor were we surprised by the announcements from a number of prominent platforms that their living annuity and endowment wrappers have run out of offshore capacity. We have seen this movie before. Clients and advisors often tactically increase offshore exposure in portfolios following currency weakness.

However, the events of 2020 appear to have left a more permanent mark on the investment thinking of many financial advisors, discretionary fund managers and portfolio managers. For most of the last 20 years, investment professionals agreed that, in an ideal world, allocating roughly 30% of a South African investor’s assets to offshore resulted in a long-term optimal risk-return outcome. In some instances, you might want to push it to 40% – but 30% is a useful rule of thumb. At Ninety One, we have frequently noted this statistic, most recently as part of our extensive modelling work on optimised portfolios for living annuity investors, which showed that holding a 30% to 40% exposure to offshore equity is a key part of solving the living annuity puzzle.1

Therefore, we have been somewhat surprised over the past 12 months to find more and more financial advisors signalling their belief that 50% is the new long-term strategic offshore asset allocation for client portfolios in an emerging market like South Africa. And this is more than just a discussion. Looking at the Ninety One Investment Platform Living Annuity, we see that, for the first time ever, the most popular investment fund (i.e. the fund with the largest share of assets in the living annuity book) was an offshore feeder fund – the Ninety One Global Franchise Feeder Fund (as at 31 May 2021).

At Ninety One, we are looking more closely into this topic, and we will weigh in on this issue in future articles – particularly in light of the debate about appropriate offshore exposure for Regulation 28.

But for now, the important takeaway for advice firms is to carefully review the client portfolio allocation decisions you made during 2020. Take a moment to assess the impact of increased volatility in your client portfolios from additional offshore exposure, and whether this is appropriate.

Also make sure your portfolio mandates and your advice records are aligned, and be clear about your mandated future strategic offshore exposure levels for client portfolios. These steps are particularly important if you have substantially increased your clients’ offshore exposure in response to the events of 2020.

Emigration and the South Africa psyche

Reports from emigration consultants about spikes in inquiries from South African residents are nothing new. These waves tend to coincide with periods of dramatic rand weakness. However, the recent changes to South African exchange control regulations with effect from 1 March 2021, have the potential to change the way many South Africans residents think about emigration.

Without diving into the complexities of exchange control and tax, the recent changes to exchange control regulations have done the opposite to what was communicated in the media. The changes have actually made the process of emigration simpler.

Under the old emigration dispensation, investors had to apply to the South African Reserve Bank for formal exchange control (excon) emigration. This was a one-way process that triggered a sequence of events resulting in the cutting of most financial ties between the emigrant and the South African financial system. This process was also quite complicated to reverse if the emigrant decided to return to South Africa. For this reason, many South African residents working overseas and qualifying for “excon emigration” only changed their tax residence, but not their “excon emigration” status.

Under the new dispensation, the concept of “excon emigration” has been abolished and everything is determined by your tax residency status in South Africa. You can leave South Africa, change your tax residency to another country but continue to hold bank accounts, investments, etc. in South Africa, should you wish to do so. And you can change your tax residency back to South Africa in future with less hassle than in the past.

This change is likely to make it easier for South Africans who have business interests/are employed abroad and spend most of their time outside South Africa, to technically emigrate by changing their tax residency to the jurisdiction where they are working. Yes, they will have to satisfy the relevant residence tests of the South African Revenue Service, and there will be a capital gains tax event on all their worldwide assets when they do change. However, they can retain their financial relationships with South African institutions, should they wish to do so. And they can return to South Africa and change their tax residence back in future.

Challenges posed by emigration changes

So, what is the impact of abolishing “excon emigration” on financial advisor firms? It turns out the impact is more subtle than it appears at first.

Because the process to change your tax residence (or reverse it) is simpler now, South African residents with existing offshore business interests or earnings are more likely to consider changing their tax residence. More and more South Africans are seriously contemplating such a move – be they senior executives at listed multinationals, pilots flying for international airlines or local businesses that are now expanding overseas.

In future, local advisors are increasingly going to have to deal with this wave of “non- resident investors”, and the implications of this should not be underestimated.

These clients want to continue their engagements with their South African financial advisors, but important new questions are being raised, such as:

  • Which offshore jurisdiction should I change my tax residence to?
  • What are the implications of a tax residence change on my various South African investments?
  • What tax will I pay on my South African investments after I change tax residence?

None of these questions are simple to answer and require detailed knowledge of the tax regulations in various foreign jurisdictions. Very few South African financial advisors are currently qualified to provide this kind of advice. However, the risk of losing the client relationship to an offshore-based tax specialist or a financial advisor means that SA advisors often feel pressured to weigh in on these issues.

How this development is going to play out is unclear at this stage. For now, here are a few questions to think about in your advisor practice:

  • Do advisors in your practice understand the extent to which they can advise on offshore tax matters, and when they should refer investors to an offshore tax specialist? The advice risk in these engagements should not be underestimated.
  • Do you understand the high-level tax implications for non-resident investors holding various South African investment vehicles?
  • Should your practice set up a working relationship with an offshore tax specialist for international clients?

Conclusion

COVID-19 and its resulting economic and social shockwaves will change many areas in our society permanently, and the financial planning and investment management industry will be no exception.

Firstly, the view of local advisors and investment managers on the ideal long-term allocation to international investments appears to have shifted. Advisors need to carefully weigh up the risks of currency volatility against portfolio returns before dramatically increasing offshore allocations.

Secondly, the gradual relaxation of exchange controls has smoothed the emigration process for South Africans. This development is driving a growing group of “non-resident investors” as clients for South African financial advisors. But taking advantage of this opportunity will demand new skills and expertise from local advisors.

These changes all have important implications for the advice and investment processes of South African advice firms and are well worth considering.

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1 Our living annuity research showed optimised offshore exposure to be 30% for starting incomes below 5% and as high as 43% for annuities with starting incomes between 5% and 6%.

Jaco van Tonder
Advisor Services Director

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