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Investing Offshore – Where, How and How Much?

Over the last couple of months, the topic of investing offshore has created quite a buzz. We have been faced with the question of whether or not investors should be “cashing in” their savings and investing everything offshore countless times. Although times are tough and confidence is low in South Africa, investors must remember to remain focused on the fundamentals and not be led by emotion. Now more than ever, investors should remain patient, stay the course and avoid making investment decisions in a panic. Offshore investments can add significant value to a portfolio – if incorporated holistically.

Let’s start with the topic of diversification

Diversification can be achieved by allocating capital to different asset classes, with one important caveat – that the respective assets are subject to different return drivers. Common examples of diversifying assets include real estate, commodities (such as oil and gold), infrastructure and hedge funds – assets that have a relatively low correlation with each other.

One way of diversifying your investment portfolio is with the inclusion of offshore assets, however, bear in mind that this asset class comes with its own set of risks. It is important to have a well-diversified portfolio that will protect and grow investments in a variety of market conditions. In the words of the famed economist and Nobel Prize winner, Harry Markowitz “diversification is the only free lunch in investing”. The main aim of diversification is to decrease a portfolio’s overall volatility without reducing its potential return.

What are my options if I want to invest offshore?

It should be highlighted that most South African pre-retirement investment vehicles already have a healthy allocation to offshore asset classes (regulation allows a maximum of 30%). In addition, the JSE Top 40 provides a decent exposure to offshore markets, since more than 70% of the earnings generated by the companies listed in the Top 40 come from outside of South Africa. These shares are more commonly known as Rand hedge shares.

If an investor wants to increase their offshore exposure, the two most common methods include:

  • Option 1: Get capital clearance from the Reserve Bank and change Rands to Dollars. These funds, now in Dollar currency, sit in an offshore bank account from which the investor will be able to allocate to most USD denominated funds. You can invest up to R1 million abroad without a tax clearance certificate.
  • Option 2: Invest in a Rand feeder fund. This process works the same as allocating to any unit trust in South Africa – except the underlying investments are all offshore based. The returns of this portfolio will be generated offshore and subject to the currency movement over that period. So you invest in Rands and will be paid out in Rands but the underlying investment is 100% offshore

How much of my capital should be invested offshore versus locally?

An investor must consult their financial adviser when faced with this question. An adviser has the ability and insight to view a client’s portfolio holistically and assist with the optimal split between local and offshore assets. The most important part is determining the investor’s goals at the outset. Without a clear goal, it is impossible to decide on the optimal asset allocation.

Key questions to consider when determining goals should include (but are not limited to):

  • First and foremost – what is your risk tolerance? Risk means different things to different people and it changes as your circumstances change. We would always recommend thinking of risk and time horizon as two peas in a pod when determining your goals.
  • Are you willing to take high risk for high potential returns, or would you prefer to have lower risk exposure, and do you understand this could potentially mean lower returns?
  • How much time do you have for the funds to grow? What is your target redemption date?
  • Are you looking to generate an income from the investment or rather seeking growth of the investment?
  • How would you react to a 20% decline in your investment—would you stay invested or would you rather cash out and invest in something predictable?
  • Concerns about potential losses or potential gains?

All of these questions are important in the process of assessing what balance of asset classes would be optimal given the risk profile of the investor.

Other key considerations:

  • Exchange rate – be mindful that you are not panic buying Dollars (or other foreign currency) at a time when the exchange rate is not optimal. Not only will you erode the value of your hard-earned Rands, but you could be buying in at such a high level, that your return might never beat what you initially invested.
  • Rand-Dollar cost averaging – consistent currency-cost averaging can result in a lower overall price for offshore shares (in terms of the price at which the share is listed for and is purchased at) and the currency rate at which you purchase the shares (in other words, how many Dollars you get per Rand amount spent).
  • Tax efficiency – tax rules differ depending on how your offshore investment is structured. With that said, you will remain liable to pay capital gains tax on all gains, tax on interest and dividends earned, and foreign dividends will be included in your taxable income – to name but a few.

In closing

We urge investors to take a holistic approach when it comes to investing and to adopt a total portfolio approach in order to diversify and minimize investment risk. Investors should strive for broad diversification and carefully assess the risk and reward characteristics that competing assets introduce to an investment portfolio.

Buying quality assets at discounted prices not only gives investors the best chance of achieving superior returns in the long run but also offers a margin of safety, which is critical from a risk control point of view.

There is no “one size fits all” approach when it comes to the split between local and offshore investments. Investors need to carefully assess the available options and choose the one that best suits their needs and beliefs.

By Eugene Visagie, CFA®, FRM® – Client Portfolio Manager, Morningstar Investment Management South Africa