/ 21 May 2010

Take advantage of ‘perfect storm’

Take Advantage Of 'perfect Storm'

If you’re serious about investing, then a portion of your savings will already be outside South Africa. The strong rand, the likely resurgence of developed equity markets after a decadelong lethargy and softer exchange controls have created the ‘perfect storm” for diversifying offshore.

The first objective for any saver is to secure real returns on his or her capital. ‘If South Africa is your country of choice then local inflation is a relevant return target for your investment portfolio,” says Larry Masson, wealth manager at FNB Private Clients.

‘Once you have determined what you need to protect your lifestyle in real terms, you can begin work on a diversification strategy.”

Investors must structure their portfolios to include an appropriate mix of assets across countries, currencies and sectors. Asset allocation begins with an analysis of your existing assets and liabilities.

A critical error is to underestimate the impact your primary residential property and existing retirement savings have on your asset mix. ‘South Africans are typically overexposed to local assets,” says Masson.

Part of the diversification process is to balance investment exposure between developed and emerging markets. But the overarching goal of portfolio diversification is to mitigate risk rather than maximise return.

So an investor who shies away from offshore equities because of the 10-year historic performance on the United States Dow Jones index is missing the point. You move assets offshore as an insurance against the performance of an individual economy.

Domestic asset classes are intricately linked to South Africa Inc, and if the economy falters then bonds, cash, equities and property often head the same way. Imagine, for example, you were wholly invested in Greece through that country’s 2009-10 sovereign debt crisis.

As governments battle for survival they will raise taxes, cut expenditure and use interest rates to underpin their currencies.

‘These interventions have a knockon effect on growth and yield in the investment markets,” says Erasmus van Niekerk, general manager asset management at Maitland. ‘It’s prudent to diversify to get exposure to more than one set of policymakers.”

Moving some of your assets into a strong offshore currency also protects you from the volatile rand. ‘South Africa is a developing economy and we expect the rand to depreciate against developed currencies and against faster-growing emerging economies over the long term,” he says.

Timing your offshore investment transactions is critical. Many local investors have a terrible track record when it comes to moving funds to and from the country.

People queue to take money out of the country when the rand crashes, and vice versa. Instead, your focus should be on consistently moving funds offshore and monitoring subsequent performance in the offshore currency. This ‘timing” error is common among retail investors, too.

‘Investors will sell an asset class that has underperformed significantly, usually near the bottom of the cycle,” says Desai Urvesh, portfolio manager at Macro Strategy Investments, part of Old Mutual Investment Group South Africa, ‘and they buy back in after the asset recovers”.

Current rand strength and the depressed state of developed equity markets provide an excellent opportunity for local investors to access foreign markets at reasonable prices. But where should you go?

‘This decision hinges on the needs and preferences of each individual investor, as well as the ability of their portfolio to tolerate risk,” says Van Niekerk. It’s also important to match an individual’s geographic liability and expense profile to their investment portfolio.

A South African resident with an extensive offshore portfolio is heavily exposed to rand volatility. Most asset managers feel comfortable with a long-term offshore allocation of between 25% and 30%.

Your offshore portfolio should include developed markets such as the US and Britain, as well as high growth emerging markets such as China and India. Investors must do their homework properly.

A professional financial adviser will flesh out your portfolio with the appropriate mix of local and offshore assets to meet your specific risk and return requirements. ‘It’s our job to make sure you invest in assets which do not correlate too closely with your existing portfolio,” says Masson.

The appropriate mix of offshore assets varies from person to person and can include bonds, equities, cash and alternatives such as property. Over the next decade investors will require additional assistance to pick the right opportunities within asset classes.

Van Niekerk says: ‘Selection has become even more important as we expect muted economic growth from the developed economies going forward.” The trick is to find the companies and financial instruments that are likely to deliver above-average growth and yield.

Wealth managers have to identify and contract with those investment specialists who consistently outperform their peers. Maitland believes there isn’t a single ‘best” vehicle or instrument to gain offshore exposure. It’s a question of which avenue fits the needs of the investor the closest.

FNB Private Wealth has a slightly different take on the optimum asset mix. It distinguishes between so called wealth-creation assets, lifestyle assets, wealth-preservation assets and excess assets. The first category comprises assets you would be invested in during your income-earning years.

‘Wealth-preservation assets are your firewall or war chest that should be preserved in real terms for long-term financial independence,” says Masson. The group has three strategies to manage wealth-preservation assets.

One of these, the growth strategy, demands a minimum 35% exposure to offshore equities. The exact percentage to take offshore varies from person to person.

South African investors have two choices when building their offshore assets. They can take money out of South Africa and buy hard currency, or they can invest in a local rand-based offshore instrument.

The consensus is to move as much as possible of your R4-million individual offshore allowance into an offshore currency. Investors with smaller amounts to invest can still get offshore protection through the rand-based solutions. These instruments include unit trusts and the increasingly popular exchange traded funds (ETFs).

Deutsche Bank issues x-tracker ETFs over a number of offshore markets, including the US, Europe and Japan. It’s important to moderate your expectations when going offshore.

Local investors became accustomed to unnatural equity returns over the five-year bull market beginning mid- 2003. And it’s going to take a while to grow accustomed to ‘normal” growth.

Old Mutual Investment Group SA says offshore returns will be tight over the next three to five years. It expects 0% real return on offshore cash and an equally disappointing return from offshore bonds.