Recent reports put South Africa’s economic growth at 1.2% in its second quarter – a rate that has exceeded expectations. However, despite an air of relative optimism amongst investors and economists alike, there is still a prevailing perception that, investing-wise, the “grass is always greener on the other side.”
Offshore investing may seem like a viable way of mitigating the trying economic circumstances that South Africa is currently facing when viewed within the broader global market. However, economic strength and valuations are only two factors amongst myriad practical considerations when deciding whether to invest domestically or abroad.
This is the opinion of chief investment officer at PSG, Adriaan Pask, who shared his perspective on whether offshore investing is a safer option than investing locally, in the wake of South Africa’s latest economic growth figures. Currently, Pask does not deny that the South African market is in a “dangerous chokehold of poverty, unemployment and weak productivity,” but argues that the strength of the economy is not always the best proxy for future investment outcomes.
Pask draws a comparison between the US and South African markets, explaining that, in the current US economic climate, valuations are priced “to perfection” and that it can be expected that the US counters will grow into their steep valuations. “As such, in terms of re-ratings, there is not much room for upward growth, or significant further gains in the near future. Currently, there are great discrepancies between US and South African valuations.
“The domestic climate found itself in the doldrums of a steep decline before the pandemic took effect, and COVID-19 exacerbated this situation. As opposed to the US, where valuations on some of the biggest stocks are at record levels, South African stocks – with the exclusion of Naspers – are on single-digit multiples. As much as this position represents substantial risk, it also signifies a number of opportunities.”
Over and above the state of the economy and valuations, there are other practical things to consider, Pask explains. “For example, Naspers holds a substantial weighting in our local index, but the problem is far greater on the offshore index. On the S&P 500, the top 10 stocks effectively account for 30% of the market capitalisation.
“We also need to be risk aware when we construct portfolios. It can’t just be opportunity-seeking. You’ve got to balance the existing opportunities with the obvious risks. The level of domestic and offshore sector-concentration needs to be considered as well. This comes into play when regulations are considered – regulations that limit your ability to invest offshore, versus the tax incentives that apply to local investments. In short, one cannot make the blanket statement that offshore investing is a safer bet right now.”
Another consideration to be made is around transaction costs. “It’s typically more expensive to invest offshore than to invest locally. This is where liquidity becomes particularly relevant. Essentially, being exposed to only one currency can leave investors vulnerable to concentration risk. The same can be said for investing in one specific asset class or in only one region. The adage, “don’t put all your eggs in one basket,” applies.”
On this point, Pask points to the early 1900s, when rail was effectively the biggest sector on the S&P. “Today, it is almost obsolete in the face of evolving and emergent technologies.” He elaborates, “The best protection you can ultimately have is diversification – making sure that you’re not solely exposed to any specific asset class, currency, sector, and the like.”
He explains that there is no “golden ratio” when it comes to how diversified a portfolio should be, but taking a 50/50 approach to local and offshore investing may be a starting point. “Ultimately, it depends on your financial goals.”
“For example, when you start to adjust for what’s happening on your estate, and what the tax consequences are, things might look significantly different. If you have a lot more capital in retirement funds where there are significant benefits, but not much in terms of discretionary capital, then your portfolio would look different from that of someone who has a lot of discretionary capital that they could potentially take offshore without being limited by our regulations. It’s really a case-by-case decision that local investors need to make,” concludes Pask.
By Adriaan Pask, chief investment officer at PSG