Philip Saunders – Market reaction to Fed announcement
Philip Saunders discusses the market reaction to the recent announcement from the US Federal Reserve Bank.
Aug 31, 2021
Having decided to invest into foreign-domiciled international unit trusts (in their dealing currency, be it dollars, pounds, or euros) some key questions remain for investors:
There are compelling reasons for South Africans to invest offshore. These include diversification benefits (i.e. access to a much wider range of investment opportunities to grow your money across countries, industries, companies and currencies), reduced emerging market (including SA specific) and currency risk, and maintenance of “hard currency” spending power.
The short answer is that it depends. It depends on each investor’s personal circumstances, risk profile and longer-term financial planning objectives. For this reason, we recommend that investors seek professional financial advice. The following, however, provides some guidelines/considerations:
Figure 1: Portfolio inclusion of domestic and offshore equities
Figure 2: SA equities out/underperform global equities over rolling 5 year periods
So, many investors need to invest more offshore than the somewhat arbitrary 30% allowed in terms of Regulation 28 of the Pension Funds Act.
In trying to answer this follow-up question, we considered the different strategies applied by investors and their advisors using the Ninety One Global Investment Platform. These strategies, which unsurprisingly are not dissimilar to the strategies followed locally, can essentially be grouped as follows:
However, there is an important question that needs answering first. How many funds should one include in a blend?
Research shows that diversification benefits are limited beyond a small number of funds. This is illustrated in the graph below, which shows how quickly the risk-reducing benefit of adding an additional fund to a portfolio dissipates. The green squares reflect the more realistic outcome, as most funds have some degree of correlation - the Holy Grail being to find funds that have zero correlation, as illustrated by the blue squares.
We have therefore limited the number of funds in the efficient global portfolio discussed below to 4, as it is evident from the green squares that there is very marginal diversification benefit to be had by adding any further funds. However, if you could find funds with zero correlation, the blue squares suggest you should consider blending 6 or more funds.
Figure 3: Decreasing incremental diversification benefit of adding funds to a portfolio
Source: Ninety One. Moderate correlation is based on a correlation assumption of 35% between assets.
Given the lack of proximity to international markets and asset managers, and the sheer number of funds from which to choose, the use of multi-asset funds for international investments is pronounced among investors and their financial advisors. For this reason, we have limited this article to blending global multi-asset funds. We have also limited our universe to funds available on the Ninety One Global Investment Platform with a performance track record of longer than 8 years, including the Ninety One Global Strategic Managed Fund. We considered the following approaches to constructing portfolios:
We then ran an optimisation exercise to maximise the expected return per unit of risk and limited the overall portfolio to a maximum holding of 30% in any one underlying fund. The results are illustrated in the following risk/return scatterplot and show a marked improvement in the risk and return characteristics of each of the blends. Interestingly, each of the 3 optimised portfolios includes the Ninety One Global Strategic Managed Fund at the maximum holding of 30%, illustrating the excellent diversification benefits that meaningful exposure to this fund adds to an overall offshore portfolio.
Figure 4: Pre- to post-optimisation risk/return scatterplot
Source: Morningstar. 8 years to 30 June 2021. NAV based, inclusive of all annual management fees but excluding any initial charges, in USD.
Finally, we repeated the exercise to establish whether a maximum 15% tilt to a sector, region or style/theme (the Quality theme is illustrated in the chart below using the Ninety One Asia Pacific Franchise Fund) would add risk-reducing and/or return enhancing benefits to the optimised portfolios. In all three instances, including Ninety One Asia Pacific Franchise Fund materially improved the optimised portfolios’ returns while mostly not adding to risk, as illustrated in the following chart. It is important though to have a high degree of confidence in the investment merits of the tilt before initiating the position.
Figure 5: The risk/return merits of a sector tilt
Source: Morningstar. 3 years to 30 June 2021. NAV based, inclusive of all annual management fees but excluding any initial charges, in USD.
In conclusion, optimising offshore portfolios results in reduced portfolio risk, and adding an appropriate sector, regional or style tilt could add additional returns to a portfolio. However, given the complexity and importance of fund selection decisions, investors are best served by seeking professional financial advice, tailored to their individual circumstances.
1 Jaco van Tonder, The importance of growth assets for living annuity investors.