Issue: March 2012 / May 2012
Is it still a valid proposition?
Mapfumo . . . strategic and tactical approaches
Mako Mapfumo, senior investment consultant at OMAC
Actuaries & Consultants, weighs up the pros and cons.
Amid concern regarding South Africa’s inflationary
pressures, local investors are well-advised still to allocate the
bulk of their capital (at least 60%) to their local economy.
This will help them to hedge away the inflation risk.
However, in some cases due to various reasons, local
assets may underperform local inflation and fail to protect
investors’ capital. In these cases, offshore exposure is a
valuable tool to diversify risk or enhance the performance
The offshore argument has been validated by legislation
which increased regulatory limits on assets from 15% to
25% over the past two years. It is important for South
African investors to understand that international exposure
can serve both as a strategic and a tactical asset-allocation
- Benefit from diversification and returns
Investors can benefit from the diversification advantages
of offshore investing over the long term as part of
Strategic Asset Allocation. Alternatively, they can enjoy
enhanced returns in the shorter term through Tactical
Strategic asset allocation makes use of the benefits
of diversification. This strategy requires long-term
exposure to asset classes that bring effective
diversification benefits to domestic asset classes.
The two key factors to consider in long-term strategic
asset allocation are:
- The effectiveness of an asset class as an optimal
- The investor’s tolerance for risk.
Historically, bonds have been the most effective assets
for diversification amongst offshore assets. They’re
followed by cash.
This is because these asset classes move together with
foreign currency to an extent that, when local markets
are going down, these assets will move in the opposite
direction. The effect is to cushion local investors in terms of local currency.
This phenomenon has become known as the “flight to
- Short-term decisions
In the short-term tactical asset-allocation decisions,
other factors (apart from diversification and the risk
profile) come to the fore. The key ones are:
- Valuation gap between domestic and global markets;
- Exchange rate (view on the outlook for the rand).
- Long-term decisions
Offshore equities offer the least diversification benefits
over the long term.
But over the short term this asset class offers the best
return-enhancement opportunities, especially when
wider valuation gaps exist between local and offshore
- Developed versus emerging markets
When looking offshore, another key consideration is the
selection between developed and emerging market equities.
Global equities are generally separated into these two
categories. Fund managers have different views on developed
markets and emerging markets.
Some managers believe they can generate ‘alpha’ by
investing in emerging market companies. (‘Alpha’ is the
risk-adjusted measure of the so-called “excess return” on
an investment, commonly used as the measure for assessing
the performance of an active fund manager. It is the return in
excess of a benchmark index or a “risk-free” investment.)
These managers argue that there are situations where risk is
adequately rewarded in these emerging-market companies.
Accordingly, the ability to identify those opportunities will
make a big difference.
A separate cluster of global managers argue that emergingmarket
gains are best captured by investing in developedmarket
companies that have exposure to emerging-market
Most global multinational corporations generate a significant
proportion of their revenue from their emerging-market
operations. These companies are better managed in terms
of corporate governance. Hence they are associated with
fewer agency problems compared to their emerging-market
Some managers, however, are indifferent about emerging and
developed-market companies. They invest in both.
What does OMAC think?
At OMAC, we concur with the view that there is a lot of
idiosyncratic risk within emerging-market companies. So we’d
prefer developed-market companies, where these companies
provide attractive valuations, that tap into the emergingmarket
However, we also recognize that there are good stock-picking
managers who can identify gems, wherever they are in the
world, without regional prejudice.
OMAC also shares the view that, for South African investors,
the diversification benefits brought about by investing in
emerging markets are limited. This is because the South
African market is highly correlated with other emerging
Therefore, allocating money to emerging markets should
be a short-term tactical asset allocation decision based on
Mako Mapfumo may be contacted at OMAC Actuaries & Consultants on