Too much offshore exposure?

In recent years, many South African investors opted to allocate increasing percentages of their portfolios to offshore investments for various reasons. Some local investors are worried about South Africa’s ongoing low economic growth and poor future growth prospects. The recent unrest in KwaZulu-Natal and Gauteng as well record levels of unemployment and increasing poverty, have caused concern about future social and political stability which prompted investors to allocate more money to offshore investments. Another consideration could simply be an expectation that offshore equity markets’ outperformance of the JSE over the last decade will continue for the foreseeable future.

While this drive to allocate more funds to offshore investments is understandable, South African investors often underestimate their actual offshore exposure. Whether you are directly invested in shares listed on the Johannesburg Stock Exchange (JSE) or invested in the average balanced unit trust fund (e.g. through retirement annuities or unit trust investments), most of the time your offshore exposure is higher than what you might think.

A balanced unit trust fund is often used in retirement products and must comply with Regulation 28 of the Pension Funds Act. Regulation 28 sets certain limits for exposure to various asset classes for retirement funds, e.g. a maximum of 75% exposure to shares and 30% to offshore assets. The average Regulation 28 compliant balanced fund, would, most of the time, provide investors with approximately 20% to 30% direct offshore investments on average over the long-term. These funds generally also allocate a significant portion towards JSE-listed shares, many of whose financial results are not only dependent on South African businesses. Many companies listed on the JSE have significant international interests.

Prominent examples include British American Tobacco which generates approximately half of their revenue from business in the United States of America, while also having significant exposure to Europe and Asia. A company like Richemont generates the majority of its revenue from business in Asia, Europe and the Americas. Another example is Naspers/Prosus that provides investors with exposure to Chinese technology company, Tencent.

These companies, along with many other international companies, often make up large portions of retirement funds, unit trust funds and direct share portfolios. Overall, investing in balanced unit trust funds (most retirement funds) with 20% to 30% direct offshore investments, combined with some international companies such as those mentioned and listed on the JSE, could provide investors with an actual offshore exposure closer to 40% or 50%. Offshore investment exposure at this level should be adequate for most investors.

The more recent introduction of global exchange traded funds (ETFs) listed on the JSE, can also assist local investors in obtaining additional offshore exposure. ETFs are securities listed on an exchange that usually tracks certain indices like the S&P500 or the MSCI World Index. By investing in ETFs, you are essentially gaining exposure to hundreds of shares included in the specific indices. ETFs can be included in direct share portfolios to gain broader offshore exposure and diversification.

Investing in these companies and ETFs also protects investors against a weakening rand in the long run.

While there is merit in including additional offshore investments in your total investment portfolio, investors should first determine their current offshore exposure, before rushing to invest more offshore. It is important to understand that if you decide to obtain additional offshore investments, they should preferably be allocated in a manner to achieve sufficient diversification. Investors should be wary of not duplicating their exposure to international companies available on the JSE, i.e. not having exposure to the same companies listed on the JSE and offshore stock exchanges.

Effective offshore diversification should therefore involve gaining exposure to sectors, investment themes or geographic locations that are difficult to obtain when only investing on the JSE or in unit trust funds investing only in South Africa. A more recent example would be investing in the global technology sector. It has generally been difficult to gain diversified exposure to some of the large and rapid growing companies in this sector (e.g. Amazon, Alphabet/Google and Microsoft) by only investing in JSE-listed securities.

The allowable Regulation 28 direct offshore exposure of 30% can be a good starting point for investment portfolios and can be suitable for most investors, but needs to be considered in light of the investor’s risk appetite and investment needs. It is always advisable to consult your portfolio manager when looking to add additional offshore exposure to your investment portfolio.

Investors should therefore carefully evaluate their current offshore exposure, consider their options for investing offshore and ultimately identify the most suitable offshore investments for their portfolio to ultimately achieve enhanced diversification and higher potential returns.

Note: The opinions expressed in this document are the opinions of the writer and not necessarily those of PSG and do not constitute advice. Although the utmost care has been taken in the research and preparation of this document, no responsibility can be taken for actions taken on information in this article. Always remember the prudent way is to consult your portfolio manager before investing.