TABLE TALK: Your offshore holdings may be higher than you think
This article was first published in the Quarter 4 2020 edition of Consider this. Click here to download the complete edition.
In the current bearish environment, many investors want to increase their exposure to offshore assets. However, many may already have a high percentage offshore without realising it.
Currently some 59% of the earnings on the FTSE/JSE All Share Index come from outside South Africa, while the local Listed Property Index has 31% of company earnings sourced from offshore. The average SA multi-asset “Balanced” unit trust’s offshore exposure, where many investors have placed their retirement funds, is over 50%. These are relatively high weightings, and offer important diversification benefits for all investors.
While each individual investor has their own goals, and therefore the appropriate amount of offshore exposure will be different for everyone, it makes sense to evaluate how much you currently have and how much you ultimately need in light of those goals. It would be value-destructive to rush offshore now and put all of your funds offshore in an emotional reaction to the gloomy views in the local market.
I’m considering taking more of my savings out of South Africa because I’m worried about the rand getting even weaker and SA’s low growth prospects. What are some of the factors I should be thinking about in deciding what to do?
There are many factors you need to consider when deciding if you should increase your portfolio’s offshore exposure, and here I’d like to mention one that is less obvious than the typical main drivers investment managers would normally highlight (those of the valuations of local versus offshore assets and the rand). At Prudential we would suggest that it’s likely be a wise move to first check what your current offshore exposure actually is – it could be higher than you think, just by already being invested in a typical South African balanced fund.
South Africa keeps globalising
It’s important to remember that the FTSE/JSE All Share Index (ALSI) has globalised in the past two decades, and this trend continues. Only a year ago some 55% of the earnings from companies listed on the ALSI were sourced from outside of South Africa, and this figure now stands at 59% as the rand depreciates versus developed market currencies and companies expand further abroad in their search for profits. Also we’ve seen numerous foreign companies doing inward listings on the JSE, many of which had no links to South Africa before. The listed property sector is also surprisingly globalised, with 31% of the All Property Index’s earnings originating offshore. That can give your JSE-listed portfolio some solid offshore diversification, depending on the companies you’re exposed to. Equally, it means you are not as likely to be as negatively impacted by South Africa’s current growth slump or rand depreciation as you might fear.
Graph 1 shows a selection of ALSI-listed companies with large portions of their earnings sourced from offshore. While Naspers is well known, others that may be less in the spotlight include UK based financial services group Quilter and IT specialist Datatec. And although the resources companies have long been strong rand-hedge plays (like BHP, Anglo American, Glencore, Mondi and Sappi), South Africa’s industrial businesses such as Bid Corporation and Imperial have also become increasingly globally diversified. Chances are, you’re already likely to be exposed to several of these companies in your existing SA portfolio given how large they are in the ALSI and their attractive diversification benefits.
Average SA Balanced Fund holding over 50% offshore exposure
And what about a typical SA “Balanced” unit trust, the most popular type of unit trust used by South Africans? We can use Morningstar data to see the asset allocation of the average unit trust in the ASISA Multi-Asset High- Equity category, and in turn get an estimate of its offshore exposure.
This is shown in Graph 2, where we find that the average SA Balanced unit trust is holding 38.2% in domestic equity (the largest asset class weighting), followed by domestic fixed income at 26.7% and offshore equity at 21.3%. At first glance, it seems like the average Balanced unit trust has approximately 29.8% total offshore exposure.
However, because we know that around 59% of the earnings from the domestic equity category are sourced from offshore, we can deduce that the average Balanced unit trust has roughly an additional 22.6% in offshore exposure (59% of 38.2%) in its domestic equity holdings. Similarly, it is has an additional 0.7% offshore exposure through its domestic property investments’ offshore revenue, but 0% offshore exposure in its domestic fixed income holdings. Adding up the various asset classes which contain some offshore exposure, we see that the average SA Balanced unit trust has roughly 53.1% offshore exposure – over half. This may or may not be an appropriate amount for your individual investment requirements, but it is likely to be far more than you had expected. This is particularly true given the lower direct offshore limits placed on retirement fund investments under Regulation 28 (currently a maximum of 30% offshore plus an additional 10% in Africa ex South Africa).
Using the above methodology, the Prudential Balanced Fund currently has approximately 52.2% offshore exposure on this look-through basis, just slightly less than the category average. This is due to our current preference for the local equities and bonds.
The SA equity market is much cheaper than its developed market counterparts. SA equities have a weighting of 45.8% in the fund (as of 31 August 2020), with some of the largest holdings including global giants like Naspers, Prosus, British American Tobacco and Anglo American. Even with its current overweight positioning in domestic-listed equities, the fund still has over 50% of its exposure to offshore revenues.
How much offshore is enough?
Each individual investor has their own goals, investment timeframe and risks to consider when determining how much offshore exposure would be appropriate to include in their portfolio. Impacting this decision is the structure of their current assets and how they are held -- whether they are subject to the Regulation 28 restrictions. For most investors, for example, their two largest assets are their primary residence (which is 100% local) and their pension fund (constrained by Regulation 28’s offshore limits). Therefore, for their other discretionary investments (outside of their pension fund) they may want to consider having more offshore exposure in order to balance their total portfolio.
The diversification benefits of offshore investments are certainly well established; not only from a return perspective but also from a risk perspective. What is most important is not to react emotionally in difficult local market conditions (or when the news and general sentiment is especially negative) and decide to take extreme measures like taking your entire portfolio offshore. Doing so now would mean that you are selling cheap South African assets and exchanging cheap rands for expensive foreign currency, and then buying expensive assets. Rather, work with an experienced financial adviser to understand what your current exposure actually is, and then what it should be based on your financial goals. In a separate article I’ll address our views on the valuations of local versus offshore assets and what this tells us about how to position our client portfolios like the Prudential Balanced and Inflation Plus Funds.