Regulation 28: Navigating offshore exposure limits
Roland Gräbe and Ubaydullah Hassen, Tailored Fund Portfolios
In February 2022 the offshore limit of Regulation 28 (Reg 28) was changed and simplified by the Finance Minister, Enoch Godongwana.
In the past the limit was 30%, but managers could also take Africa exposure in addition to the existing 30% offshore limit.
However, most managers had minimal exposure to Africa. Now it is much simpler. Overall, managers can have up to 45% offshore exposure, but Africa still has a limit of 10%.
This change applies to retirement products. Living annuities do not have to comply with Reg 28 because they are insurance products. It also does not apply to so called linked investments, or what we sometimes call, discretionary savings.
Past changes to Reg 28 limits
Originally there was a 15% offshore allowance. But over time Reg 28 allowances have moved upwards to allow more offshore exposure.
As a result, asset managers have crept closer and closer to the 30% limit which we had prior to February 2022. We expect that offshore exposure will start climbing again toward the new 45% limit.
The asset class that will probably give up exposure is local equities, which was the trend that we saw in the past.
In terms of the change, it is absolutely positive for investors. It takes nothing away from investors and basically gives everybody more options and more room to move.
We believe that we do not need much more than 45% offshore exposure. Whether the limit is 45% or 100%, offshore exposure will probably max out around the 40% mark.
With more options to construct strategies, the result should lead to more efficient portfolios, more freedom to move, more diverse views and ultimately better risk adjusted returns for the industry as a whole.
A generous limit is all well and good, but it is not without its challenges. One obstacle with offshore investing is that we invest in a foreign currency, for example US Dollars, but returns are in Rands.
The value of the Rand per US Dollar brings additional volatility to offshore asset classes.
Hence, if we are taking unhedged exposure, 45% tends to be too much. If one can hedge some of the offshore exposure cost effectively, then almost every investor should go 45% offshore.
To contextualize, our optimization results indicate that our offshore exposure, for inflation plus 6% strategies, will probably climb from 30% to 40%.
In the more conservative products, offshore will increase by only a couple of percentage points.
Valuations
The key message is that we intend to increase offshore exposure, especially for our high equity balanced strategies.
However, the Rand has weakened significantly, and it is not sitting at an attractive level to send Rands offshore.
With regards to equity valuation, we look at South African equity, global equity excluding the US and US Equity to quickly gauge relative attractiveness.
We see that world equity excluding the US is around fair value or just below. The US market is relatively on the expensive side. Therefore, from an equity perspective, it’s not a great time to rush in.
With regards to global bonds, South African government bonds are sitting at very attractive yields, especially compared to developed market bonds.
Again, it is not a great time to sell local and buy offshore.
In Summary
As much as we would like to go offshore, the opportunity set is not signalling to us that we rush and do it tomorrow.
In all likelihood, we will most probably move offshore in incremental stages and look for opportune moments where there are global sell-offs or local market rallies.
Old Mutual Wealth is an advice-led wealth management business, aimed at providing financial planners and their clients with a full suite of industry-leading strategies and services.
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