The rand has been gaining ground hand over fist against the dollar as the United States government struggles to recover post-recession. Already below the key R7 to the dollar level, analysts believe the local currency could improve further for the rest of 2010 and through 2011.
Gavin Joubert, the senior portfolio manager at Coronation Fund Managers, says the rand is overvalued on a purchasing price parity (PPP) measure. PPP looks at an equivalent basket of goods locally and abroad, and suggests the local currency should be trading at between R8 and R8.50 to the dollar.
For how long will the local manufacturing and export sectors struggle with a strong currency?
Romeo Makhubela, the chief investment officer at Metropolitan Asset Managers, says the “stronger for longer” trend will gain impetus following the latest round of quantitative easing announced by the US Federal Reserve. The world’s largest economy recently kicked off another $600-billion “money-printing” exercise, which will inevitably weaken the US dollar further.
His views are supported by Tony Barrett, the head of BJM Wealth, a specialist provider of advisory and asset management services to high net-worth individuals. Barrett believes South Africans should get used to the idea of a stronger rand: “This is the new reality and investors should explore ways of deriving benefit from it.”
Lara Warburton, the managing director of Imara’s South African asset management business, says the main themes behind the rand’s continued strength include strong demand for commodities and higher (relative to the developed world) local interest rates. Risk-averse investors searching the world for yield opportunities are finding them in South Africa.
The massive “gap” between US and local interest rates, coupled with the country’s first world financial system, has encouraged large offshore fund managers to make structural changes to their funds. Many of them now have permanent allocations in South Africa — and they’ve been purchasing local bonds and equities like there’s no tomorrow.
The strong rand is hurting some sectors of the local economy, most notably manufacturers and exporters, and trade unions and businesses are baying for the government and Reserve Bank to intervene in global currency markets to weaken the rand. But it’s not to be. There’s simply nothing regulators can do to fight international capital flows.
It’s a lesson Japan (which intervenes directly to the tune of billions of dollars in attempts to weaken the yen against the dollar) and Brazil (which introduced a tax on short-term capital inflows to protect its currency) has learned the hard way. “South Africa is a small open economy hugely impacted by the forces shaping the rest of the globe,” says Makhubela.
He says our financial markets and macroeconomic fundamentals will be affected and there’s nothing we can do about it. All emerging market currencies are strong at the moment and will remain so until the effects of the meltdown decrease.
Of course the man in the street is less concerned with international monetary policy outcomes than getting the balance in his investment portfolio right. We’ve read dozens of articles from trusted financial journalists suggesting the best time to prop up your offshore portfolio is when the rand is weak.
But they’re not entirely correct. Yes, the decision to move money offshore during periods of rand strength is sensible, but it shouldn’t be your overriding motivation for doing so.
Why should you go offshore?
The main reason to take money offshore is to achieve portfolio diversification. “Offshore diversification is justified by the numbers,” says Barrett.
“South Africa accounts for about 1% of the world capital markets — so given total freedom of choice you could never justify holding the bulk of your funds at home.”
It makes sense to take funds offshore to reduce risk and take advantage of new and exciting return opportunities. Sensible investors will use periods of rand weakness and shifts in valuations between different markets to diversify effectively.
Says Makhubela: “The key aim of diversification is to invest in assets that are not correlated in returns to the local market thereby offsetting the risk of investing in one market only.” Rand strength shouldn’t guide your offshore investment strategy, but it makes sense to invest offshore as a hedge against current rand strength.
But investors should steer away from making emotional decisions, says Mike King, the director for Africa at international fund manager Franklin Templeton Investments. The pattern has played out time and again.
Local investors watched as the rand lost ground against the dollar in December 2001 and again in late 2008. Each time they charged into their financial adviser’s office with a view to getting their money out fast. And each time they got severely burned. The only way to avoid such panic is to stick with your tried and tested investment strategy.
You should know in advance how much of your portfolio you want offshore and stick to this allocation. “Whether you’re based in South Africa, the developed world or an emerging market economy, you shouldn’t allow your investment decisions to be swayed by the performance of a currency,” he says.
Local investors need to distance themselves from the “South Africa is an emerging market” belief. For many years advisers have limited their client’s exposure to high-growth emerging markets because they believe “own country” investments offer sufficient emerging-market exposure.
“Why should we limit ourselves because we believe we live in an emerging market?” asks King. South Africa is currently growing at between 2,3% and 3% a year against double-digit growth from the likes of China and India.
A balanced offshore portfolio should include exposure to the fast-growing emerging markets and to recovering developed markets — with an appropriate spread across bonds, cash, equities and listed properties.