Imagine for a moment you are an alien, looking at this planet we call Earth. Take it further: imagine that you are given a mandate to invest, without constraint, in any continent, country or indeed company. Assuming that our alien is a rational being, without any inherent cognitive or emotional bias or prejudices, he would allocate his capital to the best investment ideas or opportunities. In all likelihood, this would mean that his allocation to the South Africa markets would be approximately 1%, as this figure reflects the country’s economic footprint in the global economy.
Offshore investing is, however, a controversial topic, especially given the experiences of many South African investors over the past decade. During this time, the overwhelming majority of offshore investments have not shown any respectable returns, whether measured in hard currency terms or in rand. In fact, once the conversion back to rand is made, many investors have found that they have lost money.
But before we make a case for investing offshore, it is worthwhile to try to understand both the context in which the past decade’s investments were made, and what transpired over the period under review. By and large, these were the fundamental drivers of the experiences that investors had. More importantly, this understanding will help explain why we feel that the next decade is unlikely to have a similar outcome.
Around the late 1990s to early 2000s, most South African asset classes were extremely attractively priced. Prudent fiscal and monetary policy ensured that the economy could thrive. With inflation fairly successfully tamed, a structurally lower interest rate environment was created. Add to this mix a favourable exchange rate – i.e. a weak rand – and low levels of household debt, and we had fertile ground for a decade of exceptional returns.
Contrast the unfavourable experience of offshore investors with that of investors who have been exposed to the South African markets, whether equity, bonds or property. The latter have experienced above historical average, inflation-beating returns from all of the said asset classes. Against this background, most investors are sceptical, and reluctant to invest offshore again or to start the process, and the question is whether one should consider investing offshore at all. After all, local has been lekker.
Today, we find ourselves in a similar position to the one we were in a decade ago, but with one important difference: offshore markets are now much more attractive than South African markets. Although they currently trade at record levels, South African asset classes do not present a compelling investment opportunity. This is not to say that many of our home-grown companies, such as Mr Price, Shoprite, and Tiger Brands, are not excellent businesses with sound management teams and good prospects. It is merely a reflection of their valuation, both on an absolute and a relative basis. A good company only equates to a good investment if you do not overpay for it; we believe many local listed companies are too expensive at the moment, with all the good news already factored into the valuations.
In this commentary, we have made the case for investing offshore largely on the basis of valuation, as this is ultimately the single most important determinant in investment performance. It must, however, also be borne in mind that political risk and inflation differentials, which drive currency movement, are also supportive of giving serious thought to offshore portfolio diversification. Historical analysis has shown that the “optimal” offshore portfolio allocation has been 30%. We would argue that a similar level of exposure would in future also ensure better risk adjusted returns.
South African investors are now virtually free from exchange control, so this level of exposure and diversification can in most cases be achieved fairly simply. Indeed, any taxpayer in good standing may externalise R4-million a year.
When asked about the secret of his success, the legendary ice hockey player Wayne Gretzky once said: “I skate to where the puck is going, not where it is.” Don’t make the mistake of extrapolating the past into the future. Local is not always lekker.