In the past year, a growing number of voices in the financial services world have been advocating that South Africans should externalise all their wealth offshore, even suggesting that individuals should cash in their retirement savings to do this. These voices were loudest at a time of peak negativity early in 2020, with the rand trading in the region of R19 to the US dollar, and the local stock market struggling.
The recent sharp reversal in both the rand and local shares would question the wisdom of having a binary view on local vs offshore, as well as highlighting the dangers of disconnecting an investor’s portfolio from the underlying investment objective it is trying to achieve.
We believe investing offshore can add significant value to a portfolio if it allows for the specific circumstances of each individual. Here we take a tour through what it means to be invested offshore by looking at the actual opportunities we are investing in, and the new risks we are exposed to in the search for returns. To understand offshore better, we start by looking at the local market.
While the JSE is a reasonably large stock exchange by world standards (17th largest by market capitalisation), we are starting to outgrow it as an investment market. On an effective basis, around 65% of our listed equity market derives its revenues offshore. This is concentrated in a relatively low number of shares, but increasing as domestic shares expand offshore. As listed companies outgrow their domestic growth prospects, it is natural for them to look outside of our borders for opportunities. This has been the case for a long time; however, because our market has a relatively low number of shares, the composition can change, and has done, quite frequently.
Ten years ago, we had almost half of our equity market (and by extension, pension funds!) invested in commodity producers. Today this is much less, replaced by Naspers (Chinese tech platform), British American Tobacco (cigarettes), Anheuser (beer) and until recently, Steinhoff (European furniture).
This has meant that in our “local” investments, our equity market is dominated by a select few offshore companies, so in many respects, we are offshore investors before we even set foot there.
What then are the benefits of investing offshore, if we can already access it in our home market? There are a few key points:
- Diversification: being a smaller market, it is highly concentrated in a few shares (eg Naspers is 19% of the market), whereas offshore markets have a huge range and depth of opportunities, so we are not beholden to the successes (Naspers) and failures (Steinhoff) of a few.
- Diversification away from South African-specific risks – economic, social and political.
- Access to new types of investment opportunity in sectors not represented locally. Examples would include biotech, energy, technology and utilities (electricity producers).
- Investment returns that are “hard currency” based – ie returns earned in currencies that generally appreciate against the rand such as the dollar, euro and pound sterling.
Looking then at the range of global options available to us, we take a first step of asking what exactly it is that local investors require from their offshore portfolios? By doing this we ensure that they can gain exposure to the full range of opportunities, taking into account the fact that because the world is a big place, global managers have quite limiting biases in where they are comfortable investing. By looking at the world through a wider lens we can ensure that we correct for these biases.
Broadly, we look at global investing – specifically equities – as six separate sources of return which provide investors with alternative opportunities to what we have access to locally.
“The source of innovation” and the home of the large “old-world company”. The US accounts for over half of all listed equity on the planet, so it is hard to avoid a US bias in a portfolio. Not that this bias is necessarily a negative as companies listed there are subject to high corporate governance standards, liquid capital markets, quality management and entrepreneurial culture, which provide the platform for a broad and deep opportunity set for investors. Of late, the US has migrated to a tech-biased market with the FAANMS increasing their share of the market as these new platform/tech businesses breach their respective tipping points.
A more pragmatic take on this change would be that tech in itself is less of a sector in the future, and more of a business as usual underpin for the bulk of industries. Tech will become pervasive in our portfolios, like it or not. With their size and reach, many US companies derive their earnings outside the US, with companies like Unilever as an example reliant on emerging markets for 57% of its revenues.
Around 40% of US company revenues are sourced globally. So, investing in the US gives us exposure to stable old-world companies, innovative new-world companies, and a range of sectors not available locally, many of which are doing business globally. This is a direct product of the globalisation of trade trend we have seen over the last couple of decades.
Rest of world developed equities
Around 35% of listed equity then sits within Europe, UK and Japan. This is a more diversified pool of investments compared with the US, given the geographical spread of companies and the fact that multiple governments play a role in impacting the prospects of each market. Europe is still rather old-world (consumer goods, financial services and all the oil companies – Total, BP, Shell).
The UK is largely a global market, with a minority of revenues sourced domestically, and many of its listings based on commodity companies, much like South Africa. Japan was the equity powerhouse in the ’80s with the advent of the personal computer and consumer electronics but has faded over time. Today it gives us motor manufacturing (Toyota, Mitsubishi and Honda) and Sony among others.
These are markets defined as “developing” ie where there are reasonable infrastructure and governance to support growth and where the standard of living is in ascendance, currently holding around 15% of world equity exposure. These are generally seen as high-growth sources of return as the underlying economies are developing at a higher rate than more mature markets like the US.
While this is the theory, the reality has been somewhat more mixed in many cases. With political volatility and various social conflicts, emerging markets are not always a one-way bet. They are also beholden to the demand created by the developed markets. China, for instance, could be referred to as the manufacturer of the Western world. Looking ahead less so, but certainly looking backwards. Countries include BRICS (Brazil, Russia, India, China and South Africa) as well as South Korea, Taiwan and Mexico.
Emerging markets are increasingly dominated by the rise of China, which now accounts for over 30% of all listed emerging market equity. And within this, a huge bias towards technology via Tencent (the source of Naspers’ success), Baidu and Alibaba – the Chinese equivalent of Facebook, Google and Amazon respectively. It is becoming difficult to avoid a Chinese tech bias inside an emerging markets portfolio. Other sectors providing opportunity in emerging markets include commodity producers, large growing consumer services based on growing middle classes, and the financial services needed to fund this growth.
Many asset managers avoid investing in emerging markets given the complexity as well as the need to resource significant teams to cover this disparate universe of shares. This is one of the biases we consider when looking at client portfolios.
A recently termed market referring to lesser developed, prospective emerging markets. Current exposure is concentrated across Argentina, Kuwait, Vietnam and Nigeria where 60% of all listed shares are either in financial services or telecommunications – the frontier markets provide high-growth opportunities because they still have much to achieve so returns to investors need to be commensurately high to offset the investment risks of politics, liquidity and governance.
Some companies are small for a reason and will stay that way, but others are the “large caps of the future”. These shares are your typical high-growth companies because they tend to be rolling out new, disruptive services to the market. Many of the current-day disruptors are technology-based, but this can cover any industry globally.
This is another market often underinvested by asset managers due to the different mindset required and additional resources required. This asset class also tends to be quite US-heavy due to the focus on innovation which enjoys substantial support in that market.
Unlike locally, where property tends to be quite homogenous – meaning that most of our investment options are bundled property companies across commercial, retail and industrial options – global counterparts are considerably more specialised. Companies can have a specific focus (eg data centres fast replacing retail shops due to online shopping), or a regional focus (for instance, a property share that only invests in B-grade London commercial property). This provides substantial diversification opportunity for investors compared to history.
All of this results in tens of thousands of listed shares in which to invest globally. In the main markets, this is narrowed down to around 2 500 to 3 000 shares, once liquidity has been factored in. This range of diversification is the primary benefit to local investors – not being overexposed to a few shares, singular governments, local currency or other risks such as terrorism, corporate fraud or the decline of an industry.
For equity investing going forward, it pays to think globally as part of a client’s portfolio, and while there are equivalent risks globally to those which we face in South Africa, we are less exposed to any individual event permanently impacting our portfolios and the achievement of longer-term objectives.