The local stock market has delivered disappointing returns over the past five years, barely beating inflation. It has been a painful period for equity investors, not only relative to the great returns we have seen in the past, but also relative to the returns local investors could have generated by investing offshore.
However, as Hannes van Zyl, principal investment consultant at Alexander Forbes says, hindsight is always 20/20. He said that the ultimate return when investing in assets denominated in a foreign currency depends on two sources:
- The return on the offshore account;
- The return on the currency.
For example, if a South African invests in an S&P 500 index tracking portfolio, the ultimate rand (ZAR) return over any period would be determined by the US dollar (USD) return on the index, plus the change in the value of the ZAR to USD currency exchange rate.
The graph below compares the South African stock market, relative to an offshore equivalent, over the five years ending 31 March 2019.
An initial investment of R100 000, at 1 April 2014, in the FTSE/JSE All Share Index would have resulted in a relatively poor investment return, when compared to the rand return of investing in the S&P500 (in ZAR) over the same period.
Based on this five-year past performance of the South African equity market, and coupling it with the current political uncertainty and low economic growth expectations, it is unsurprising to see how easily investors could conclude they will never see double-digit returns in the local equity market again, said Van Zyl.
Source: Alexander Forbes Investments and Bloomberg
Alexander Forbes pointed pointed out that costs and charges have not been considered. Income is reinvested. It added that the graph above is for illustrative purposes only and should not be considered as advice.
“Despite the many warnings about the dangers of investing our money based on past performance, this information still drives most investment decisions, as it enables us to rationalise the decisions we make, to invest in the midst of an uncertain future,” said Van Zyl.
“Unfortunately, uncertainty is a part of investing, and it is safe to say that local investors are not faced with uncertainty for the first time.”
Having a portion of one’s long-term investments (retirement or discretionary) allocated to offshore assets makes a strong investment rationale.
“Not only does the ability to invest offshore increase local investors’ investment opportunity set, but it also provides great diversification benefits. However, blindly allocating all your capital to offshore investments only also holds risks.”
Van Zyl said that when deciding on the optimal percentage of investor assets to be invested offshore, the following should be taken into consideration:
- The currency in which investors’ liabilities are based;
- When future liabilities (cash flows) are based in one currency and investments are held in another, currency risk needs to be considered. Any positive returns in a foreign currency investment can either be dampened or enhanced by an appreciating or depreciating local currency.
Decisions driven by emotions
“The journey to steadily growing wealth can often be marred by emotions that drive irrational actions with undesirable outcomes. Investment decisions informing portfolio construction should consider financial goals (such as retirement spending needs) and be based on rational and attainable outcomes, said Van Zyl.
“An investment strategy that is tied to needs and expectations rather than emotions can help investors navigate the peaks and troughs of the market with confidence.”