This year will go down in history as a year of extreme stock market volatility. Each time investors feel brave enough to venture back into equities, sovereign debt concerns resurface and wipe out their short-term gains.
There are opportunities offshore, but savvy investors will wait out the uncertainty. Over the past 18 months fund managers have cajoled local investors to avail of the strong rand and move some of their funds into offshore equities. Those who acted on this advice will probably be unimpressed by the returns generated on their investments thus far.
Then again, thanks to recent rand weakness, they’re in a better net position than if they’d left their funds in South African shares. Their “gains” are largely due to the rand shedding 14.1% against the US dollar over the 12 months to September 30 2011.
Choppy markets
Why have offshore equity markets been so choppy? Global stock markets have been plagued by myriad debt and growth concerns since early 2010. “The black hole at the centre of the economic universe is the indebtedness of European governments,” says David Green, chief investment officer at PPS Investments. And the overarching issue right now is how the Euro-zone will not only overcome Greece’s inevitable insolvency but also meet subsequent liquidity demands from financial institutions with exposure to the region. We are by no means safe from a full-blown monetary crisis either. If Greece falls, the likes of Italy, Portugal and Spain could follow in a domino-like collapse.
Caution ahead
Should investors consider bulking up their offshore holdings given ongoing market uncertainty? A couple of quarters ago asset managers would have answered with a resounding yes. Today they are more cautious. “It’s far more important to focus on the valuations available in the various major asset classes from time to time, as opposed to forecasts for the future of their associated economies,” reckons Green. He says equities on local, global developed and global emerging markets are more attractively priced entering Q4 2011 than for some time. In stark contrast, fixed interest assets have become extremely expensive.
Green cautions that the apparent discount in equity prices reflect “deep economic uncertainties that are still playing out”. Investors should monitor market developments carefully and consider the implications on their preferred investment instruments. This cautionary stance is echoed by Craig Pheiffer, general manager: investments, at Absa Asset Management Private Clients. His advice to retail investors is to take a year off while the markets settle, and only make slight tweaks to their portfolios. “Those who get the urge to make big portfolio changes at this time of year should think things through carefully,” he says.
Connected world
His warning follows the rather dire Q3 2011 performance from domestic equities. In yet another demonstration of the interconnectedness of world markets, South African investors sold out of the JSE All Share in response to an asset sell-off by troubled European banks. Concerns about US growth quickly masked the more positive local indicators. Absa isn’t convinced investors should rush offshore just yet. They believe that, due to the average price-to-earnings (PE) ratio on the JSE FTSE All Share index being below its long-term average, you are better served in local opportunities. They favour resources stocks and carefully selected industrial shares over financial companies. If you have to go offshore, you should stick with multination companies trading on low PE ratios and offering attractive dividend yields.
Many US blue chips are offering the best value since 2002, with very enticing information technology shares. Absa investment analyst Chris Gilmour mentions the likes of Pfizer, Microsoft, Cisco, Coca-Cola and Johnson & Johnson in the US and Tesco in the UK. Marriott Asset Management favours a similar share picking strategy offshore. “Large companies with global markets offer attractive yields, and this is where investors should be focusing their attention,” it says. The trick is to find companies with reliable dividend streams and high dividend yields — an easy task in today’s suppressed markets. The dividend yields of some of the largest global multinationals are now well above bond yields. This, coupled with favourable equity valuations, presents investors with significant opportunity to generate inflation beating returns over the next five years.
Funds are popular
You can get a feel for South Africa’s appetite for offshore investment by studying activity in the collective investment schemes space. The popularity of funds with offshore exposure is evidenced by the 351 foreign currency denominated funds on offer locally. And by June 30 2011, locally registered foreign funds had assets under management of R112-billion. Foreign currency unit trust funds (denominated in currencies such as the dollar, pound, euro and yen) attracted R3.4-billion in Q2 2011, with R1.3-billion from retail investors and the balance from institutions. This category of fund has to be registered with the Financial Services Board and local investors wanting to invest must comply with Reserve Bank foreign exchange regulations. But institutional investors don’t seem to be in a hurry to go offshore just yet.
According to Franklin Templeton South Africa, there was little sign of a race offshore following changes to National Treasury’s foreign investment ceilings. Tanya King, business development manager at the firm, observes: “The retirement fund ceiling went up 5% to 25%, a significant increase permitting a sizeable adjustment in portfolio allocations.” Despite the relaxation, the group estimates the average offshore allocation among retirement funds is between 13% and 14%. The offshore investment industry will be hoping the global economy strengthens, bringing their equity-rich funds back in play. If the rand remains range bound between R7.50 and R8.30 to the dollar, foreign currency funds should continue to attract both retail and institutional support. As King notes, prolonged periods of relative rand strength to the US dollar create what some may see as a timing opportunity.