Issue: April/May 2007
Edutorials
RMB

Why South African investors should also invest offshore

Investing offshore has two potential benefits - performance and diversification of risk. The local investor can receive the same or even better returns at a lower risk when offshore investments are included in his portfolio.

How does this work?

World economies don't always grow at the same time, which means that many countries' investment cycles are at different stages at any one time. Some countries' investment cycles are peaking whilst others are starting to recover. Investing offshore allows the investor to take advantage of the fact that offshore investment cycles are often different to the investor's local investment cycle. By investing offshore the investor's return is diversified into a number of different countries and investment cycles, instead of being a function of one country's investment cycle.

The following example uses our South African equity market returns, and the US equity market returns to represent offshore investments, shown in the table (above right), where returns are given in rands. The equity returns of these two equity markets are similar over the 16 year period. The domestic equity market returned 16.6% pa and the US equity market returned 15.1% pa for the same period. But what is more important is that the returns from the two markets are seldom similar in the same year, and differ in size and direction over the period. The range of returns (in rands) varies from 37% outperformance by the South African market in 1993, to 63% outperformance by the US market in 1998. It is these differences that provide the investment case for investing offshore.

Long Term South African and US Equity Returns

Year Equity Return
(%pa)
US Equity Return
(%pa)
Difference
(%pa)
1990 -5% -6 % 1%
1991 31% 35 % -4%
1992 -2% 17 % 19%
1993 55% 18 % 37%
1994 23% 3 % 20%
1995 9% 38 % -29%
1996 9% 54 % -45%
1997 -5% 36 % -41%
1998 10% 53 % 63%
1999 61% 25 % 36%
2000 0% 11 % -11%
2001 29% 38 % -9%
2002 -8% -45 % 37%
2003 16% -3 % 19%
2004 25% -7 % 32%
2005 47% 15 % 32%
2006 41% 25% 17%
Compound Ave, Growth 15,2% 14,5 % 0.7%

SA Rand vs US Dollar

YearRand Contribution
(%pa)
1990-0,3%
1991-6,6%
1992-10,1%
1993-10,2%
1994-4,1%
1995-2,8%
1996-22,1%
1997-3,8%
1998-17%
1999-4,5%
2000-18,8%
2001-37%
200239,6%
200329,8%
200417,5%
2005-10,8%
2006-9.41%
Compound Ave.Growth-5,5%

Reducing overall risk

The other side of the return story is risk. Returns from different assets (such as equities, bonds and cash) often offset each other, and when combined, they reduce the portfolio's overall volatility or risk. Some of the factors which impact on the risk to an investment are currency risk, political risk, the volatility of return of a particular asset class, disclosure and different accounting procedures.

Offshore investment returns are made up of the return from the offshore assets plus the gain or loss from the rand exchange rate over the period. Looking at the rand's performance against the dollar (shown in the adjacent table) it can be seen that the exchange rate plays a big role in offshore returns, with the rand only outperforming the US dollar in 3 of the last 16 years.

Rand weakness over this period contributed 5.74% p.a. to the returns of the offshore assets. Thus rand weakness contributed 38% of the 15.1% returns on US equity to South African investors. Clearly the exchange rate plays an important part in any investment offshore.

Portfolio Construction

When constructing an investment portfolio, an investor seeks to maximise returns for a given level of risk. Research has shown that an efficient investment portfolio would include offshore assets, assuming that it is the investor's objective to at least outperform domestic inflation over the longer term. This portfolio would include domestic equity, domestic bonds, cash and property along with the offshore assets. Our research has shown that the percentage invested offshore should ideally be between 32% and 35%, depending on the return objective of the portfolio.

Conclusion

The case for investing part of a portfolio offshore comes from the difference in timing of returns from financial markets. Returns often peak at different times, as investment cycles do not always synchronise together. The result is that for the same level of risk a portfolio's returns may be improved by including offshore assets.

www.rmbam.co.za
info@rmbam.co.za