Neil Thomas taking stock
The problem with anything popular or fashionable is the ineluctable allure of the unobtainable. As soon as you can’t have it, you want it even more. Offshore unit trust funds, at least those of the rand- denominated variety, have recently attained this Joycean status. The initial impulse, soon after South Africa’s new government began to ease foreign exchange controls, was understandable, even healthy. Confined, at least in legal terms, to invest in local markets and assets, the relaxation of the forex rules naturally saw keen interest in investing offshore. This was hugely facilitated by the introduction of rand-denominated unit trusts, popular because they were affordable, hassle-free (no tax certificates or special clearance), and did not eat into an individual’s forex allowance. And, dammit, we should all have the right to invest our money where we want to. But now a second wave of inverse motivation has entered the offshore equation. The initial rush into offshore funds earlier this year, strong as the rand weakened, became an epic flood of Mozambican proportions as Robert Mugabe wobbled the regional economy like a three-year-old riding without flywheels for the first time. So by the second quarter of the year the bulk of new small investors’ money was flowing into offshore funds – about R2,5-billion of it. Not entirely rational, perhaps, but understandable as these funds were not only providing welcome diversification away from higher-risk emerging-market equities, but were also offering the best returns. Then came the catastrophe. Record inflows into offshore funds began to deplete unit trust management companies’ asset swap capacities, and, just like Jericho, the walls came tumbling down. Now most rand offshore funds are closed to new investments, and investors are missing them like a daily fix of caffeine or nicotine. Old Mutual Asset Managers is a case in point. In March they launched 10 new rand offshore funds to meet the growing demand that kept closing their successful Global Technology fund to new business. Barely four months later all 13 Old Mutual funds had to cap new investments, and a similar refrain could be heard throughout the unit trust industry. The frustration of investors is palpable. It’s worse than telling 16-year-olds that they can’t watch a 21- year-age-restriction movie – it’s like telling them after they’ve watched it. But now that the latest investment fad has temporarily been halted – and it is unfortunate, and something the finance minister should take a close look at – it’s a good time to question the wisdom of rushing offshore.
I’ve repeated, ad nauseam, that investing in offshore funds is a capital idea, especially considering our closeted investment history. But it’s a capital idea for diversification, not for chasing short-term returns or following the latest investment craze. Diversification is about controlling risk and lowering the volatility of a portfolio. It’s a means to trying to get the optimal performance from a portfolio, certainly not an end in itself. Unfortunately, that aim seems to have been lost in the rush offshore. The fact that the strong offshore unit trust inflow coincided with a period of out- performance did not help either, but that won’t last forever. So far, it has mainly been courtesy of the rapidly weakening rand, with secondary support from a flaccid Johannesburg Stock Exchange. While it’s a safe bet that the rand will continue to decline against the major world currencies, at least until that happy day when we reach a similar level of inflation as our main trading partners, the rapid depreciation seen this year has been abnormal. Zimbabwe has been a reason, but even more so the strong United States dollar. That’s now starting to falter and the rand is firming up, so the party may be over.
Of course this should not concern investors who went offshore for the right reasons. But to continue pumping money into offshore funds, lemming-like, does not make investment sense. The aggressive investor who is purely after the best possible growth (and has the discretionary money to risk) might well be tempted offshore. But then it won’t be into a safe international fund-of-funds, made up of comparatively low yielding US and European investments. Emerging markets, smoothed over the inevitable shocks and blips, offer the highest returns – hence the risk premium. And the hot offshore markets for the seasoned risk-taker now are in Mexico and Brazil, maybe even Japan. And potentially in South Africa too, where equity prices are extremely low and offer strong recovery prospects. When this dead cat bounces it should be spectacular, maybe even electric enough to bring the stiff feline back to life. But why listen to me, when a few of the experts out there who make a real living out of this sort of thing are also starting to question the wisdom of the flight offshore.
One is John Stopford, a portfolio manager with Investec Asset Management, who is not afraid to question the trend. He asks whether it is reasonable that, over the past quarter, 23% of local unit trust investors’ money is in money market funds, 7% in domestic bonds, half in domestic equities and 20% in foreign funds. The short answer, says Stopford, is “no”.
But here’s where his bias comes out. He says: “Holding 7% in fixed income funds is inappropriate. Not only have bonds been the best-performing local asset class over most of the past decade, they look set to comfortably wipe the floor with cash, and do perhaps as well as equities.” Stopford is a fixed-income expert, and he could well be right about the superior investment qualities of domestic bonds, for a number of cogent reasons. My argument is simply not to invest offshore because everybody else is doing it, that’s a recipe for getting hurt.
By all means diversify until a comfortable portion of your portfolio is offshore. That will help to lower risk. Then look at other assets if you really want to grow your wealth. There are many ways of skinning a cat, even if it only looks dead.