Jun 28, 2019
Given the diversification benefits, reduced emerging market and currency risk, and maintenance of ‘hard’ currency spending power, investors are regularly reminded of the wisdom of investing offshore and not adopting an investment strategy that focuses only on South African assets. However, 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 is therefore a key factor to take into account. In fact, 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.
This shorter-term impact of the currency is clearly illustrated in Figure 1 below. The first chart shows the performance of the Global Franchise Fund in dollars and the performance of the Global Franchise Feeder Fund in rands for the year to 31 March 2018. The second chart reflects the same but for the year to 31 March 2019.
What can we learn from the charts in Figure 1? The one-year dollar returns of the Global Franchise Fund were both positive at 11.2% (31 March 2018) and 9.9% (31 March 2019). However, the one-year rand returns of the Global Franchise Feeder Fund are significantly different at a disappointing -2.9% (31 March 2018) and then an impressive 33.9% (31 March 2019)!
Clearly, the appreciation and subsequent depreciation of the rand has had a significant impact on investor returns – in the first period providing a strong headwind to performance and in the second a strong tailwind!
Figure 1: One-year returns of the Global Franchise and Global Franchise Feeder funds*
Table 1: Annualised returns (%)*
|GLOBAL FRANCHISE FUND A ACC||MSCI AC WORLD NR||GLOBAL FRANCHISE FEEDER FUND A|
*Past performance should not be taken as a guide to the future, losses may be made. Data is not audited. Source Morningstar Direct, dates to 31.03.18 and 31.03.19, NAV based, inclusive of all annual management fees but excluding any initial charges, gross income reinvested, in US dollar (Global Franchise Fund) and ZAR (Global Franchise Feeder Fund). Highest and Lowest refers to the highest and lowest 12-month rolling returns since inception. Highest: 45.0%, Lowest: -40.0% – Global Franchise A Acc share class (**launch simulation date: 10.04.07). Highest: 54.4%, Lowest: -35.1% – Global Franchise Feeder A class (inception: 21.05.96). The total expense ratio and transaction cost for the Global Franchise Feeder A is 2.09% and 0.0%, respectively.
All things being equal, economic theory states that investors can expect a domestic currency to depreciate in line with the differential between that country’s inflation rate and those of its major trading partners. With inflation within 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 2 illustrates the overall deteriorating performance of the rand against the US dollar since 1972. The chart 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 2 is above the green line it suggests that the rand is cheap and vice versa. The pink and grey lines represent two standard deviations (2SD) – cheap or expensive. This simply means that we expect the rand to trade within these bands about 95% of the time.
Currently, PPP is suggesting that the rand is close to fair value and therefore, over the longer term, we can expect the rand to continue to depreciate. It is worth noting, however, that the rand has very seldom traded at fair value, and has also traded at expensive and cheap levels for extended periods of time.
Figure 2: US dollar/rand purchasing power parity
Source: I-Net Bridge, Bloomberg and Ninety One SA (Pty) Ltd as at 30.04.19 – log scale.
Investors’ personal circumstances, risk profile and longer-term financial planning objectives are all important factors to consider when investing offshore. We therefore suggest that investors consult a professional financial advisor. There are, however, a number of ways to gain exposure. These include:
We believe that when investing in international assets, investors need to take a longer-term view and look past the shorter-term movements of the currency. However, this is often more difficult said than done, and highlights the benefits of appointing a good financial coach who can assist investors in staying the course.