Why invest offshore?

The benefits of investing offshore and the impact of the exchange rate on returns.

Aug 23, 2019

4 minutes

The benefits of investing offshore and the impact of the exchange rate on returns.

Investors are regularly reminded of the wisdom of investing offshore and not adopting an investment strategy that focuses only on South African assets. There are a number of compelling reasons for investing offshore. Briefly, these include:

  • Diversification benefits – investing in international assets allows for greater diversification, which is a key investment principle for reducing risk. In addition, investing in international markets provides access to countries, currencies, asset classes and industries that are not available locally.

  • Reduced emerging market risk – South Africa remains an emerging market, albeit with pockets of first world industries (e.g. banking and mining) and infrastructure (e.g. roads, ports and railways). By world standards though, we are a small, open economy with a relatively illiquid and volatile stock market.

    Interestingly, while the FTSE/JSE All Share Index makes up less than 1% of the world’s market capitalisation, South Africa’s gross domestic product (GDP) comprises only approximately 0.5% of the world’s GDP. Why is the size of market capitalisation compared to GDP so high in South Africa? The reason is that our country was amongst the earliest adopters of a market exchange aimed at raising external capital to finance business activity, which happened to be mining at the time. (The JSE was founded by Benjamin Woollan in November 1887 to provide a market place for the shares of South Africa’s many mining and financial companies that resulted from the discovery of the Witwatersrand goldfields in 1886.) It was not until more recently that financial markets geared towards raising external capital became a feature in many other emerging markets, including Russia and China.

    Why is this relevant? Index trackers and many global portfolio managers base their allocation to a particular emerging market on relative market capitalisation, not GDP. It is likely that other emerging markets will, over time, see a proportional increase in their market capitalisation in line with their relative GDP, thereby reducing South Africa’s relative market capitalisation. Ultimately, this change will likely mean less capital flows to South Africa, which will put pressure on the rand.

  • Reduced currency risk – all things being equal, economic theory states that one can expect a currency to depreciate in line with the differential between that country’s inflation rate and those of its major trading partners. With inflation around the mid-point of the South African Reserve Bank’s 3 – 6% target, South Africa’s inflation rate exceeds the inflation rates of its major trading partners. Therefore, over time, we can expect the rand to depreciate against these currencies.

    Figure 1 illustrates the overall deteriorating performance of the rand against the US dollar since 1972. The graph also uses the theory of purchasing power parity (PPP) to illustrate the relative cheapness or expensiveness of the rand against the dollar over time. (PPP is a theory which states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries.) When the dark green line in Figure 1 is above the green line it suggests that the rand is cheap and vice versa. The pink and grey lines represent two standard deviations (SD) – cheap or expensive. This simply means that we expect the rand to trade within these bands about 95% of the time.

    Currently, therefore, PPP is suggesting that the rand is on the cheap side. However, it is important to consider South Africa’s worsening terms of trade, general risk aversion and continued US dollar strength. All these factors are potentially negative for the rand.

    Figure 1: US dollar/rand purchasing power parity

    US dollar/rand purchasing power parity graph 

    Source: I-Net Bridge, Bloomberg and Ninety One SA (Pty) Ltd as at 12.08.19, Log Scale.

  • Maintenance of ‘hard’ currency spending power – it is important for South Africans who travel abroad or who purchase imported items (or any product or service priced in an international currency) to ensure that they maintain (and grow) their spending power in real terms.

A long-term view is required to fully benefit from offshore assets’ return potential

While the case for investing offshore is compelling, it is important to consider where the return from an international investment could come from: the exchange rate and/or the underlying foreign investment. The impact of exchange rate risk on a foreign investment should also be an important consideration. Many South Africans got burnt when they invested offshore in 2001 and 2002 when the rand traded at around R12 to the US dollar. As a result, South African investors now tend to have an underweight exposure to foreign investments.

Studies have shown that when considering the historical returns of foreign investments, the impact of the exchange rate is uncertain and volatile, and that when measured over shorter time horizons, the exchange rate can have a significant impact on the investment return in rands. Research indicates that it is only over longer time horizons that the underlying investment contributes more to the return than the exchange rate. Therefore, we are of the opinion that when investing offshore, investors need to take a long-term view to fully benefit from the return potential of the international assets in which they are invested.

A global specialist asset manager

We believe Ninety One SA (Pty) Ltd is well placed to assist South African investors looking to diversify offshore. With some 250 investment professionals based across the globe, including the UK, Asia Pacific, the Americas and Africa, Ninety One SA (Pty) Ltd now manages assets for six of the ten largest sovereign wealth funds. And while Ninety One SA (Pty) Ltd has built an impressive track record in managing global asset class and regional/sector funds, we have created a simplified core range of investment solutions (conservative, balanced and aggressive) for South African investors seeking to diversify offshore.

Figure 2: Ninety One SA (Pty) Ltd's core international fund range

Ninety One SA (Pty) Ltd's core international fund range

Authored by

Paul Hutchinson

Sales Manager

Important information

This communication was originally published by Investec Asset Management (Pty) Ltd, the predecessor of Ninety One SA (Pty) Ltd. The information is accurate as at the original date of publication, but any views expressed may no longer be current. The communication has been republished in our new branding but has not otherwise been updated.

All information is as at 30.03.19 unless stated otherwise.
All information provided is product related, and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Investec Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing, up to 10% of fund net asset value to bridge insufficient liquidity, and scrip lending. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. A feeder fund is a fund that, apart from assets in liquid form, consists solely of units in a single fund of a collective investment scheme which levies its own charges which could then result in a higher fee structure for the feeder fund.
The offshore funds are sub-funds in the Investec Global Strategy Fund, 49 Avenue J.F. Kennedy, L-1855 Luxembourg, Grand Duchy of Luxembourg, and is approved under the Collective Investment Schemes Control Act. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant Total Expense Ratio (TER). A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The ratio does not include transaction costs. The current TER cannot be regarded as an indication of the future TERs. Additional information on the funds may be obtained, free of charge, at www.ninetyone.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. Ninety One SA (Pty) Ltd (“Ninety One”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA).
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