/ 21 April 2010

Icy black swan

Jeremy Gardiner makes the case for investing offshore

There is a term in financial markets known as a black swan event. This term describes an event that has a significant impact on financial markets, but which could not/was not predicted by anyone. A volcano in Iceland leading to massive “eruption disruption” certainly could not have been predicted by anyone. Certainly, market commentators were expecting some form of financial explosion out of Europe, but not a volcanic one!

Fortunately it seems to be “blowing over” and within a week the world should be back to normal. However, this, together with charges against Goldman Sachs and ongoing fears over Greece, could just have provided the catalyst for the much-expected correction markets have been anticipating for close on six months now.

Greece is fixed, for now. The EU and the IMF came to the rescue, which is good because it averted a default, but it is also problematic as it sends out an implicit signal to errant EU countries that there is a lifeline waiting if they need it.

Germany is unimpressed, with Angela Merkel even threatening to develop a smaller, more disciplined collection of Euro countries than the current diverse bunch that comprises (or compromises) the EU. Unfortunately, Greece is not alone, and potential financial explosions from a variety of other European countries remain quite possible. Volcano-induced silence in the skies above Europe certainly hasn’t helped either.

2010 thus far has been predictably choppy, with markets generally grinding upward, far more slowly than last year, as the wounds from the financial crisis gradually heal. Equity markets, having run ahead of themselves, are more circumspect this year. Economically, while developed market economies limp towards recovery, the developing world, with Asia and in particular China, remains rampant.

Meanwhile, back in South Africa, Investec Asset Management hosted an investment conference last week. The conference consisted of several panel discussions featuring South Africa’s leading portfolio managers and the common theme throughout was that, given how hard emerging markets and South African equities have run, money managers are bearish on future returns from current levels. While there wasn’t much discussion around potential crises or corrections, single-digit equity returns for South Africa going forward seemed the consensus.

So what should South African investors be doing?
Future returns depend enormously on what price you buy your assets. The choice at this stage is tricky. Nothing is particularly cheap, and although equities are more attractive than cash, potential equity returns are not that appealing and do carry risk.

One area which South Africans should be considering is offshore diversification. The rand has run hard and is not expected to maintain current strength for too much longer than the World Cup. While the direction of the rand is impossible to call, you could probably rely on some weakness at some stage going forward.

Unfortunately, however, most South African investors are jaundiced towards offshore investing, after having (along with the rest of the word) invested every cent they could, by hook or by crook, into the US markets at the end of the nineties. At that stage, the US markets and the US dollar were viewed as “bulletproof”, and the South African markets as “avoid at all costs”.

Since then, i.e. for the first 10 years of this century, the US dollar has halved and the US equity markets basically delivered a zero return. Over the same period, the South African markets returned 15,8% per annum in US dollars.

The lesson there is twofold:

  • Firstly, no financial asset goes up or down forever. There was a time people thought the US dollar only went up and the rand only down. Rather, financial assets all go through periods of over- and undervaluation, and it is the level at which you buy them that is important
  • .

  • Secondly, be careful of buying anything after a strong run or an extended period of strong returns, as your potential returns going forward will be limited.

So purely from a currency perspective, the timing for diversifying offshore looks favourable.

Jeremy Gardiner is a director at Investec Asset Management

Read more news, blogs, tips and Q&As in our Smart Money section. Post questions on the site for independent and researched information.