Offshore investing - Allan Gray
Offshore investing

Beyond our borders: A case for investing offshore

Investing offshore should always form part of your long-term diversification strategy. South Africa comprises about 0.3% of the world’s market capitalisation – ignoring the other 99.7% could be detrimental over time. Horacia Naidoo-McCarthy talks us through the four key reasons to invest offshore, reminding us of the associated risks and sharing some pointers to consider when determining the optimal balance of potential offshore return at a palatable level of risk.

“I am not the same, having seen the moon shine on the other side of the world.” – Mary Anne Radmacher, author.

While home may offer great comfort and safety in the known, there are enriching experiences and learnings to be gained from venturing into the great unknown. The same can be said for investing. Many of us suffer from “home country bias”, which means that we invest a disproportionate amount of our savings locally.

What do you gain from investing offshore?

Investing offshore allows you to take advantage of global opportunities to create a diversified portfolio that can protect your investment from a range of risks and deliver robust returns over time. Following, some of the most compelling reasons for offshore investing are discussed.

1. Your investment risk is spread across geographies and economies
As part of your long-term investment strategy, investing offshore allows you to spread your investment risk across different economies and regions. In doing so, you improve your chances of achieving returns when one region may be underperforming, and you avoid being overexposed to a particular region or currency. As an example, while the Nasdaq fell more than 30% in 2022, Brazilian and Indian equities delivered positive returns.

2. You have access to companies and sectors not represented locally
South Africa does not have a developed technology sector, nor does it have a biotech sector or any of the number of exciting fields that have the potential for growth. Lithium is an example of an investment that is not available locally, but is poised to play an important role in the global push to transition to clean energy, given its use in energy storage.

3. You can earn returns from different asset classes at different times
As with local investing, if you blend asset classes that typically do not move in sync (i.e. their returns are not correlated), you can potentially protect your portfolio returns, which means that if one asset class performs poorly, returns should come from other parts of the market. As an example, since 1999, South African equities and bonds have had a low correlation with their global equivalents, and an even lower correlation across asset classes. This diversification benefit has the potential to bolster the portfolio in a range of macroeconomic scenarios.

4. Your investment is protected from local currency risk
Imported costs are not an insignificant part of South African consumers’ expenses, and to battle offshore inflation and currency movements, you need to protect your portfolio from local currency risk.

… it is necessary to invest offshore to protect your investment from whatever the rand may do in the future.

The rand is one of the most tradeable and volatile emerging market currencies. South African motorists are all too familiar with the pain at the pumps, as a weaker rand is one of the contributing factors to ever-increasing petrol and diesel prices. Numerous other dollar-denominated goods, which include clothing, electronics and entertainment, continue to put pressure on local consumers. As such, it is necessary to invest offshore to protect your investment from whatever the rand may do in the future.

Finding the golden ratio

There is no scientific formula that gives you the perfect answer to how much to allocate to offshore investments. Regulation 28 of the Pension Funds Act provides strict investment limits for retirement funds, which are designed to protect members’ retirement savings from being overly exposed to a single asset or concentrated basket of assets. This regulation suggests that 45% offshore exposure diversifies your portfolio, but still manages the risk that comes with offshore investing. After all, more offshore risk does not necessarily equate to greater returns.

Graph 1 illustrates the benefits of finding the balance between potential returns and risk by looking at the returns of global equities (MSCI World Index), local equities (FTSE/JSE All Share Index (ALSI)) and a fictitious portfolio that combines the two. As you can see from the graph, over time, a 50:50 ratio of both indices provides decent returns through the cycle. This is not to say that a 50:50 split is optimal, but it demonstrates that a diversified portfolio of assets dampens extremes and can be used as a risk control measure.

Graph 1_Return profile_300dpi.jpg
There is no one-size-fits-all answer. You need to figure out the right ratio for yourself, with the assistance of a good, independent financial adviser, if need be. As with other investment decisions, consider your unique investment objectives, risk appetite and lifestyle.

Key risks associated with investing offshore – and how you can think about them

Travelling to foreign lands is exciting – exotic cuisine, intriguing cultures and attractions to be marvelled at – but every seasoned traveller knows that the risks of travel need to be carefully managed too. Having a clear idea of areas to avoid, possible illness and what to do when you arrive without your luggage, for example, prevents you from being blindsided and allows you to have contingency plans should those scenarios materialise.

Similarly, while there are many good reasons to invest offshore, it is not without risk. The expansion of the opportunity set is accompanied by a risk-return trade-off, which should not be ignored when selecting unit trusts for your portfolio. Unit trusts like the Allan Gray Balanced and Stable funds weigh up these risks to optimise the risk-reward profile. While valuation (the price you pay) should be at the core of your investment decisions, it is important that you are cognisant of the different risks weighing on your investment:

1. The risk of the unknown
Investing globally means venturing into unfamiliar territories with different languages, different regulatory, financial and accounting systems and different cultures and customs. Trying to navigate this landscape with limited knowledge, flow of information and understanding may be challenging, but this should not discourage you from investing offshore. Allan Gray and Orbis conduct in-depth research and aim to better manage both known and unknown risks.

2. Political and economic risks
The fact that almost half of the world’s population will be heading to the polls this year makes it particularly pertinent to assess the potential impact of a country’s political climate on your investment. While investing offshore gives you access to a much wider investment opportunity set, you are inherently exposed to economies and geographies that face their own unique challenges. Although some of these will not pose obvious risks, you should be aware that changes in regulation or changes in government can have a significant impact on your investment. A relatively recent example of this was the sudden Russian invasion of Ukraine, which saw listed Russian stocks and business interests go to zero given sanctions.

However, political uncertainty and volatility are quite often temporary and can result in attractive opportunities for long-term investors like us. While investors tend to be attracted to economies that are doing well, data from long time periods suggests that strong economic growth does not necessarily mean there will be good stock market performance. Japan is a fitting example, with real GDP only growing 1.9% in 2023, in contrast to the stellar 25% return of its market, the TOPIX. As an individual investor in a global fund, understanding the rationale of portfolio managers is key when investing in riskier countries and regions.

3. Currency risk
Exchange rates have a profound effect on the returns of international investments. Not only do you need to consider the company that you wish to invest in, but also the currency of the market that the company operates in, and whether the overall mix of currencies will serve as a good long-term store of purchasing power. It is important to understand the impact of currency on your investment returns. The underlying price of your investment fluctuates, but so does the value of the currency.

… timing the market is difficult, and we believe a steady strategy of diversification will serve you better over the long term.

As South African investors, we often focus on our returns in ZAR, but currency matters. As currencies oscillate from relative strength to weakness, we often see startling swings in returns. For example, in 2015, a South African investor would have had a 34.6% rand return investing in the MSCI World Index, while the very same investment would have lost about 0.3% in US dollars. However, in 2016, a US dollar investment would have done much better.

The historical behaviour of South Africans indicates that we tend to rush offshore as the value of the rand deteriorates in the hope that we will protect our investments. This is counter-intuitive. Buying offshore investments when the rand depreciates means we are buying expensive offshore investments with a relatively weaker currency. The more rational time to invest offshore is when the rand is stronger. This will enable you to stretch the value of each rand used to purchase offshore investments. However, timing the market is difficult, and we believe a steady strategy of diversification will serve you better over the long term.

4. Liquidity risk
Liquidity is a term used to describe how quickly an asset can be bought or sold. Portfolio managers will always consider the degree of liquidity across various markets and think carefully about pursuing investment opportunities within markets that are relatively less tradeable – i.e. where it may be difficult to sell the investment. Liquidity constraints and considerations tend to be more prevalent within emerging markets. Ideally, a portfolio should have sufficient liquidity to meet withdrawals and be in a position to take advantage of future investment opportunities.

5. Hidden costs
Investing in certain markets or countries may incur additional costs. Over and above some of the transactional costs, there may be exchange control regulations and tax implications in foreign jurisdictions.

Investing offshore is a long-term play

The above risks all need to be acknowledged and understood, but, at the end of the day, we believe that the risk that matters most is the price you pay for an investment. Partnering with an experienced investment manager allows you to outsource investment decisions to a team with a track record, which focuses on understanding the ins and outs of what each company is fundamentally worth and whether the stock warrants a position in the overall portfolio, while also considering currency with the aim of delivering a return in the best mix of currencies.

Investing offshore can be richly rewarding when a considered, long-term approach is taken.

With its more than 30-year track record and global footprint, our offshore partner, Orbis, offers a range of funds (equity, multi-asset, absolute return) that meet a broad spectrum of needs and are easily accessible directly through Orbis via our offshore investment platform, or via the newly launched Allan Gray Offshore Endowment (see Julie Campbell’s piece). In addition, Allan Gray portfolio managers look after a portion of the global portfolio, as well as the Africa ex-SA Equity and Frontier Markets Equity funds and the Africa Bond Fund. Together with Orbis, we provide access to different economies, geographic regions and a broader selection of opportunities.

Investing offshore can be richly rewarding when a considered, long-term approach is taken. Start early, and remain patient and focused.

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