The move away
A change in thinking among the investor community towards offshore diversification is becoming increasingly evident, driven in part by attractive yield value in several overseas property sectors.
Historically, South African property companies have been precluded from investing offshore.
Exchange-control issues aside, forward yields on foreign property investments in highly developed countries such as the United States, the United Kingdom and other European centres have been far too low to be attractive to South African listed companies. This was because the acquisition of such foreign assets would be income dilutionary to local funds, which in turn would have had a negative effect on the acquirers’ share price.
But according to Brian Azizollahoff, chief executive of Redefine Income Fund, the advantages of limited offshore diversification have made even dilutionary acquisitions somewhat palatable as there is a mitigation of risk from the perspective of geographic concentration, as well as a natural rand hedge when the local currency weakens.
“What is very attractive in the current world economic climate is that there is value in the property sectors in the US, Europe and Australia never before offered. Yields on both direct property as well as listed property companies are at highs even above yields in South Africa.”
Azizollahoff cites the movement in price of three of the largest UK real estate investment trusts (Reits)—Land Securities, Hammerson and Liberty International. “The drop in value is dramatic—up to 50%—although the net asset values have not decreased in the same proportions,” he notes.
He says that when looking at the US market one of the major Reit management companies is Cohen & Steers, which manages 12 listed entities. Two of their listed Reits—Worldwide Realty Income Fund and Reit & Preferred Income Fund—are trading on yields of almost 12% and 20% respectively and there are numerous other Reits trading on yields in excess of 10%, offering US-based assets in quality portfolios.
So what is the significance of all this for South African offshore investors? It is, Azizollahoff says, that the significant drop in property value is by no means confined to the listed property sector. Anecdotal evidence is of prime real estate in the UK trading at yields of 8% and 9% and in the rest of Europe (for example Germany) between 10% and 12%.
The US is no different and “appetite” for property is at very low levels where, once again, anecdotal evidence is of initial yields of about 10% for prime properties in large centres. “The issue of exchange control is a complex area of law and requires each investor to take an opinion,” says Azizollahoff. “Similarly, the ability or capacity for an investor to borrow funds offshore also varies from investor to investor.
“If one considers that the cost of gearing in the US, Europe and Australia is substantially below that of South Africa, utilising offshore financing facilitates the opportunity to acquire yield-accretive property investments in developed countries that has arguably never been this attractive.”
Adam Benzimra, business development executive with Ashburton, says: “South Africa is still regarded as an emerging market. This tends to make the South African stock market more volatile than that of first-world countries, increasing the risk of local investment. Diversifying your portfolio across several countries is also a way of smoothing out your returns, combining investments from economies experiencing rapid growth with those that are growing more slowly. No single country will be home to all the best investments in the world and a portfolio with an international flavour will have greater potential to grow over the long term.
“Currency risk should also be an important consideration for investors aiming to lower the risk of their portfolios - it would simply be poor risk management to ignore the possibility of a slide in the value of the rand. A good example is the weakening of the rand over the past few years against a basket of major currencies. Some foreign currency exposure would have ensured some protection for local investors.”
Benzimra says that although many investors looking for offshore exposure often opt for the MSCI World Index—which includes a selection of stocks of all the developed markets in the world, as defined by MSCI—there are significant risks to this approach at present. “The MSCI is still heavily biased towards the West and we are taking a longer-term view that with property valuations—and debt and income inequality—at extremely high levels, these markets contain a lot of risk.
“From an equity perspective, most of the future potential is probably sitting in Asian markets, most of which will leverage off the China and India story. From a valuation perspective, while these markets may not appear that attractive over the short term, their longer-term prospects are incredible.”
Benzimra says that according to the efficient frontier model, about 30% of a local portfolio should be invested offshore. “Rather than using such calculations, which do not differentiate between individuals, it is more important to look at each specific client’s needs and when and why he needs the money. For example, if the client has a short-term investment horizon, he might not be able to ride out a geopolitical crisis in a particular country. Everyone recognises the importance of asset allocation between asset classes such as equities, bonds and cash, for instance. The same importance should be placed on asset allocation between markets.”