Over the past five years South African investors have been heavily focused on externalising liquid assets into the offshore investment arena. Is this still the case? Which routes to diworsification are finding favour? What are the risks and the geopolitical issues at play? And where are the opportunities?
There are two primary reasons for this externalisation of wealth from South Africa and for the offshore investing conversations currently taking place around the country.
First and foremost, the South African market has been underperforming offshore markets, both developed and emerging (see accompanying chart). This underperformance has been significant both in base currency and in rand terms as illustrated. Secondly, political and socioeconomic risks, or the perception thereof, have risen and investors are looking to externalise that risk by investing their capital offshore.
The latest statistics from the Association for Savings and Investment South Africa provide enough evidence of the continual movement of cash into offshore vehicles.
But are these factors still in play? And is the drive to send wealth offshore still seen as an imperative by local investors?
South Africa vs the world in 2020
There is certainly a strong case to be made that both reasons to externalise investments still exist.
South Africa continues to downgrade economic growth and political risks continue to confront potential investors. The issue of land grabs has again resurfaced and the Zondo Commission into state capture is a rather slow work in progress. As a result, the local stock market continues to splutter.
Most developed stock markets do not look stretched when compared with the South African market on a valuation basis. Even if one feels that emerging markets will outperform developed markets through the next cycle, there are certainly several emerging markets that look far more attractive on a valuation basis versus South Africa. This makes the case for investing outside South Africa an attractive one.
The diversification driver
When investing the term diversification always tends to crop up. After all, it makes perfect sense to utilise the entire investable universe in seeking the maximum risk-adjusted return to suit your profile or circumstance. That said, one could suffer from diworsification as there is a vast array of instruments and asset classes available to investors in the market place.
Under the current economic cycle, we believe the two best options for diversification (while not giving up potential alpha or return) would be to invest in an actively-managed balanced service, or a concentrated equity service populated by what we would consider to be quality stocks.
When investing in a balanced service you are making use of asset allocation to drive return as well as mitigate risk. The approach is twofold in that you need to ensure your balance between bonds, cash and equities that meets your risk tolerance while ensuring that the bond and equity instruments utilised within the service are the correct picks. A top down and a bottom up approach would be prudent.
The challenge for balanced fund managers currently is that bond yields are at multi-decade lows and cash gives you a negative return after inflation. If one looks at the role central banks have begun to play in the world economy interest rates look set to stay lower for longer, this makes it tricky to squeeze return in those two asset classes.
When investing in an equity service you are relying on the equity instrument to drive your return as well as prescribe or predict your risk, hence our approach to what we would consider quality stocks. Quality means different things to different managers. To us the characteristics we would look for in a stock to qualify as quality would be issues such as cash return over the cost of capital, high profitability, strong balance sheet and low earnings cyclicality, while continuing to monitor factors such as dividend yields, cash buy backs, shareholder treatment, price-to-earnings ratios, price-to-book ratio amongst others.
It would also be remiss not to touch on the impact of technology when considering investment opportunities, particularly since it is the tech sector that has led the returns charge over the last cycle. We believe the earnings generated in this space are certainly healthy enough to underpin further gains in equity prices for the oligopolistic tech companies.
Geopolitical risks and opportunities
There are various risks at play around the globe currently, which must also be considered from an investing perspective – particularly one with an offshore focus.
Geopolitics continue to interfere with the free market, trade negotiations in the United Kingdom have begun post Brexit, trade discussions and tariff threats continue between the United States and China, and the Coronavirus has begun to show its teeth economically around the globe. In mid-February, HSBC (the largest bank in the East) reported a 33% decline in profits and is set to layoff some 35 000 employees globally.
These risks do, however, present opportunities for investment in well-positioned quality stocks. From technology to biochemistry and financial services, it goes without saying that environmental, social and governance considerations will remain front of mind when investing in the new decade.
Currencies too are always a popular discussion point. Of course, one must try not to get caught up in currency speculation, since currencies very rarely trade at fair value for longer than a few seconds, giving truth to the saying that currencies are like a broken watch; they are only right twice a day.
Daily pricing spread (ZAR)
Source: Ashburton Investments
Daily pricing spread (US)
Source: Ashburton Investments
Ultimately, there are no free lunches and each investment vehicle comes with its own inherent risks. However, there is no need to take on undue risk to achieve superior returns; that in essence is the job of the fund manager to strike the right balance.
For those South African investors looking to the rest of the world amidst challenges at home, it’s critical to ensure that you are invested in the correct mandate for your risk tolerance and understand how that mandate operates. In this new decade, knowledge will continue to set successful investors apart on the world stage, while having the right expert in your corner has never been more essential.
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