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25 Jan 2019 00:00
Rüdiger Naumann, portfolio manager at Investec Asset Management
The ability to invest more offshore due to the relaxation of foreign exchange controls over recent years broadened the opportunity set available to South African savers. However, while this has the potential to deliver a more attractive outcome, it may also pose an additional risk to local savers if not correctly managed, according to Rüdiger Naumann, portfolio manager at Investec Asset Management.
He contends that offshore assets now make up a sizeable portion of most individual investors’ portfolios as well as most retirement funds, yet these assets are often managed independently by third-party managers as stand-alone portfolios.
When separating the on- and offshore asset allocation and asset selection decision, the combined portfolio may generate a suboptimal risk-return outcome.
“Portfolio construction theory relies heavily on the concept of diversification, which maintains that holding assets with low correlation to one another can deliver returns at low or lower volatility.
“Most studies achieve optimal offshore allocations of around 30%, the top end of which is currently allowable under regulation 28. In practice, however, the facts may provide only limited support for this argument.
“Two crucial aspects are important to consider: how uncorrelated are the assets in question and which historical returns are used for calculation purposes. Are they really as poorly correlated as the theory of diversification postulates? If not, or not significantly, is the major tenet of diversification and by implication, allocating investment capital offshore not in question?
“The second and related aspect to consider is that of prospective returns: do the potential investments offshore provide for fair, reasonable or even superior return payoffs? Or, stated differently, are investors sacrificing returns in their search for lower volatility? If this is indeed the case, lower returns — and lower volatility — may more easily be achieved through a more defensive investment strategy within the home market.”
Naumann says as is so often the case, the answer is somewhat more nuanced than a simple for or against. In our view, the diversification argument only holds when paired with returns that are on par with or superior to what may be achieved at home.
In other words, our motivation for investing offshore relies heavily on attractive stand-alone investments while mitigating the risk of the overall portfolio of investments.
“A completion approach, whereby assets that present both as compelling stand-alone investments and which are complementary to those assets already held, is the best justification for investment outside the home market,” explains Naumann.
“The size of the South African market pales into insignificance compared to both the size and breadth of investments available globally. A larger opportunity set naturally allows investors greater choice of investments and hence making investments accurately aligned to their respective and distinct investment strategy.
“However, the resources required to effectively make investment decisions in a large, less familiar market may act as a serious handicap to South African investors hoping to achieve a superior outcome to local-only investments. Offshore investing necessitates deep resources, specialist skills and experience across a broad range of asset classes and investment strategies.
“Furthermore, South African investors expose themselves to risks not adequately considered or not considered at all. One such risk is that of currency risk, a natural consequence of allocating capital across different global regions.”
Naumann points out that while some investors seem satisfied that as long as they have global investments, their objective of superior, risk-adjusted returns will be achieved. However, he argues that this is far from correct.
“Unfortunately a static or fixed allocation to global assets is neither appropriate nor optimal. While on a standalone basis, this seems practical, offshore investors should always consider their global investments in the context of their overall, South African-dominated portfolio.
“This requires a flexible approach, where asset allocation and instrument selection are responsive to varying market and macro cycles across all aspects of the portfolio, both domestic and foreign and in combination.
“In our view investors are best served by an integrated or holistic approach to building the portfolio, rather than opting for bolt-on, stand-alone or even third party allocations managed without thought for the portfolio as a whole.
“Integrated management demands dynamically varying allocations to different asset classes, regions and sectors, always informed by the impact on the portfolio as a whole,” says Naumann.
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