It's all about the price

A cursory glance at the fund fact sheets of the majority of the better asset allocation funds out there shows one call common to most: all the funds are presently sitting at or near their maximum allocations to foreign investments.

Having spent most of November visiting financial advisors and clients across South Africa, we have been singing the praises of the long-term benefits to clients of appropriate offshore exposure in a portfolio. Most advisors we speak to are in agreement with this principle, but when it comes to the man in the street, our support for foreign investments are frequently greeted with some derision. We think that much of this may be laid at the door of the fact that many of these investors bought their foreign assets at some time since the mid-1990's. Why do we say that?
Today we would like to highlight two issues regarding foreign investments.

The graph below shows two basic pieces of information for the period between the start of 1981 and the end of October 2009 (using monthly data). The red line shows the 10-year PE of the S&P500 Index and the light green line the dollar-rand exchange rate. The values of the PE appear on the right axis and the value of the exchange rate on the left.

Good Long-Term Returns are Generated from Buying Cheap Assets
Focussing on the PE's, we note firstly that we have used the 10year PE of the S&P Index in order to help decrease the cyclicality of earnings. The horizontal dotted blue line shows the average PE over this period at 16.34 times 10-year earnings.(It is noteable that the long-term average 10-year PE of the S&P going back to the 1870's is also exactly 16.34 times). It is clear from the graph that the decade of the 1990's saw ever-rising PE's on the S&P, culminating in a peak at the end of the last millennium at more than 44 times earnings. Hardly surprising then when, for the next decade, we have seen an unwinding of these over-inflated values back to the current level of about 19 times.

The Currency has a Long-Term Trend and Short-Term Opportunities
Focussing on the exchange rate, we can see that in January 1981, one US dollar bought about R0.75. Last month one dollar bought about R7.80. The month-end exchange rate is the light-green line. Since 1981 the rate of change in the exchange rate has fluctuated significantly over short periods, but the dollar has shown a long-term appreciation relative to the rand over this period of an annualized 8.5% per annum. This trend is shown by the dark green dotted line.

Again, we can see that, despite a relatively consistent appreciation during the 1980's during the 1990's the rate of appreciation of the dollar relative to the rand was significantly faster than the long-term trend has proven to be, culminating in a peak at the end of December 2001, when a dollar could buy you about R12.00. It is also clear from the graph that, at present levels, the exchange rate is below the long-term trend which, if the trend remains intact, would tend to indicate that some dollar appreciation is due at some stage in the future.

So What Does All This Mean?
Investors who took their money offshore at the end of 2000 have been worst-hit by a general decline in the prices of global equities and period of depreciation of the dollar relative to the rand. From a valuation perspective, the S&P was expensive to very expensive relative to its long-term average. The risks of the average value of stocks returning to their means was very high - and played out in due course. At the same time, the appreciation of the dollar relative to the rand was very overdone relative to what we now see the long-term trend being and paying R12.00 for a dollar in 2001 was definitely too much.

Investors, who have long-term perspectives, will appreciate that the S&P is now about fair value relative to its long-term average price. Thus the risks of buying these foreign stocks is at an average level. At the same time, the rand appears to be relatively strong in relation to the long-term trend. There is now a chance to buy foreign assets at a fair value, with the optionality of a rand which, if the trend continues, depreciating in the coming years relative to the dollar.

The risks of investing in foreign assets now is significantly lower than they were 10-years ago. We are advising investors who have foreign assets to be patient and to wait-out the trends. We are also advising investors who are underweight their appropriate allocation of global assets (ask your advisor who much you need over the long-term) to take advantage of this opportunity to get equities at fair value with the optionality of some rand depreciation.

The Alphen Angle is an electronic newsletter of Alphen Asset Management. To read more about Alphen please go to www.AlphenAM.co.za

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The Dumb Investor The retail investor will only go offshore when ZAR is 10 :1 to USD Not now -it offers to much value That why they lose money buy at the top -sell at the bottom Ahmen by Ken Alles on November 29 2009, 07:25 Find this comment inappropriate? Report it

Mystified Some years ago the wisdom was to have a little overseas to diversify - up to 15%. Now the finacial pundits talk about up to 40%. Proper diversification to world makets should make this 99%. by How much overseas? on November 29 2009, 20:11 Find this comment inappropriate? Report it

Are Colective Fund Managers common criminals or just cadres? 10 years ago did any Collective Fund send out advisories to their "finacial advisors" to advise clients not to buy overseas funds? Did any fund manager collecting fees, socalled for thier superior knowledge and performance, stay away from overvalued . .more equities at overvalued dollar prices. No, they are only compared to benchmarks by equally stupid fund managers, sort of the least stupid is the winner, even if they loose half the clients money, and the winner even gets a bonus! 20 years ago there were a handfull of funds to choose from, today hundreds, its like the FED, a resipe for printing money, without any risk to fund managers and principles. . .less by Suckered on November 30 2009, 09:53 Find this comment inappropriate? Report it

The big scam is that the SA market is driven by the rand exchange rate. So, by logical deduction your time you purchases when the rand is strong OR your buy a basket of strong currencies when the rand is strong. The later removes the market equity market risk which is a smaller part of the potential gain in RSA. . .more Hers how to get the worst out of your foreign investment. You buy offshore risky assets (such as equities)when the rand is strong. When the offshore equity markets are booming, so are offshore currencies, ie the rand is relatively weak. Your return is diluted by following the common sense of your advisor. This is a long winded way of saying "take the currency ris or the equity risk by all means. Do not take both - your dilute your returns. . .less by Free the Rest on November 30 2009, 10:20 Find this comment inappropriate? Report it

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