Given the rand's recent wobble, the question most investors are asking again is whether to invest offshore or not and, if so, how much of their portfolio should be invested in other countries. Unfortunately for those who want a simple answer, there isn't one: much will depend on the investor's specific circumstances.
However, take a look at the following graphs, which are instructional in providing some guidelines for making decisions about investing abroad.
In Chart 1, we have plotted the average annual returns in dollars for the South African equity market (FTSE JSE All Share Index) and global equities (S&P 500 and MSCI Developed Markets) versus dollar inflation over 10-year rolling periods and, in Chart 2, we show the same but in rands versus rand inflation.
Chart 1: 10-year (annualised) rolling returns - US dollars
Chart 2: 10-year (annualised) rolling returns - SA rand
What these graphs demonstrate is that there are some very long-term cycles at play.
From the mid-1990s until the early 2000s, SA equities were characterised by poor returns while global equities experienced great returns. We see this divergence in terms of performance in both the dollar and the rand returns.
During the 2000s, these roles were reversed: we experienced a decade of excellent returns for SA equities and dismal returns for global equities. Again, these trends held true in both rand and dollar terms.
While the 1990s were a period of rand weakness and the 2000s a period of rand strength, the greater influence on performance was the actual equity market movements rather than the currency movements.
Implications for making the "offshore" decision
There are some very powerful observations to be made from these graphs which can guide investors with regard to their offshore decision:
- Over time, the performance of equity markets moves around long-run averages (the equity risk premium). Extended periods of superior returns are likely to be followed by extended periods of subpar returns: nothing outperforms forever. The 1990s ended on very high valuations for offshore markets and attractive valuations for South Africa, which informed much of the following 10 years of returns. It is, therefore, unsurprising that SA equities performed well in the 2000s, after a decade of relatively poor performance, while global equities did the opposite.
What is the likely path forward given the above observation? Mean reversion implies that the great returns of SA equities of the last decade are unlikely to repeat themselves, and the poor returns of global equities are unlikely to repeat themselves.
- And what about valuations? The price that is paid for an investment (its valuation) is also critical to longer term returns. At the moment, South African equities are on a Cyclically Adjusted PE of 16.1 times, global equities on 16 times and US equities on 18.2 times, approximately at their long-term average. So while our market is marginally more expensive than global equities and cheaper than the US, the valuation differences are not compelling enough to motivate a wholesale switch to another market. We do, however, believe that pockets of our market are very expensive (such as large cap industrials and cash retailers) and represent high investment risk.
- Don't base your decision on a view of where the currency is going. Firstly, movements in the rand are likely to defy logic and one's forecast will be incorrect. Secondly, as the graphs indicate, the performance of the asset you own is far more important than getting the currency right. In other words, it's your asset selection and not currency selection that matters. Short-term investment decisions on currency moves are nothing more than speculation. Try to avoid these and rather look at your long-term asset allocation.
- Hence, base your decision on the advantages of diversification rather than on expected currency moves. This can be explained by the fact that there are shares and other investments overseas that are simply not available in South Africa; assets that are useful in diversifying risk given their different business markets and earnings drivers. For example, in South Africa, you simply can't buy exposure to businesses like BMW or Samsung.
- So even if mean reversion and diversification points your portfolio overseas, don't rush to invest all your assets in overseas equities. Investors who live in South Africa have their liabilities or living expenses mostly in rands. Putting all their assets overseas means they get poorer in periods of rand strength. Ask investors who had most of their portfolio overseas in the early 2000s how that decade felt for them. Also note that over extended periods, South African equities have always beaten South African inflation, unlike global equities. Perhaps the old adage of "Don't put all your eggs in one basket" applies here.
- Interest rates and yields have historically been higher in South Africa than overseas and this is likely to continue. For people such as retirees, who are living off the yield of a portfolio, the offshore income will be pretty meagre when compared to local income levels.
Considering all of these observations and the guidelines flowing from them, we suggest that while long-term trends and valuations indicate that global equities are likely to do better than domestic equities, investors shouldn't rush for the door, or take a view on the rand's current weakness to inform their view.
Rather, investors should look to allocate assets to global investments, or increase their current global equity allocation, while being cognisant of their own risk profile, their need for income and their South African liability status.
