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HNWIs’ money should be invested globally, directly

Not being content with an SA fund invested abroad.

The recent South Africa 2014 Wealth Book revealed that South Africa’s 47 464 high net worth individuals (HNWIs) hold only 17.4% of their wealth outside of their home country, significantly lower than the global average of 20-30%. This is a very risky strategy in any country, but when you also note that the rand is one of the most volatile currencies in the world and people who keep all their investments in South Africa are also exposing themselves to political instability, the risk becomes crystal clear.

For many investors who fail to diversify across international markets, the reason for their “home” or “domestic” bias is simply lack of experience or a feeling of unease at the prospect of offshore investment and the potential tax or cost implications which may arise. A reliance on local firms and investment opportunities is understandable when that is what you feel comfortable with, but these investors would almost certainly change their strategy if they knew the scale of the opportunity presented by international diversification, and the opportunity cost presented by their limited domestic equity funds.

The chart below compares international markets not according to land mass, but by the size of each country’s stock market relative to the world’s total market value. Whilst the US is by far the biggest market, some of the other countries’ relative share may surprise you. China, Japan, Germany, France and the UK, which make up the next five biggest economies (as measured by GDP and according to the World Bank), make up a combined share of just 22%. The implications here are significant as the domestic investor in developed financial centres such as South Africa, or even Spain and India, are exposed to just a fraction of the global equity market, heightening local market risk, whilst limiting exposure to offshore gains.

Click on image to enlarge

Figure 1: World Market Capitalisation (£23.1tln as at 31 Dec 2012)

What’s clear is that there are significant benefits to investing outside of your domestic market, but beyond that it becomes all but impossible to determine which market will deliver the best returns. Therefore, it makes sense to diversify across as many countries as possible, exposing your investment to the largest and most developed capital markets, while elevating your risk-adjusted return.

For investors currently limiting their portfolio to home opportunities, the first and most important step is breaking the domestic-international divide. It may be daunting to venture into unknown financial territories but with the right guidance they can develop well-balanced funds that are managed with a global strategy, informed by expert local knowledge.

For South Africans especially, there is an urgency about this need. What many South African investors do not realise is that the range of offshore funds approved by the FSB is limited, so they end up doing asset swaps that are very expensive. The result is inefficient offshore investment management and higher costs which, in many cases, investors are not even aware of. Investors should rather be insisting that their FSB-regulated IFA partners with a provider that is regulated to invest abroad. They should not be happy with a South African fund invested abroad – they should insist that the money is invested globally directly.

The South African stock market represents just 1% of global market capitalisation. For domestic biased funds, that’s 99% of untapped potential. Couple that with the volatility – both political and economic – to which home biased investments in South Africa are subject, and the issue becomes clearer. If you plot the rand against the VIX global volatility index, you’ll see the extent to which money flowing in and out of the country is tied to the volatility of global markets. And equity portfolios there are heavily weighted with FTSE/JSE Top40 stock, so sector bias is added to currency bias and the result is a worrying lack of diversification. When South African investors take these factors into consideration, in terms of both the risks inherent in the country’s markets and the compounded risks associated with investments penned in by national borders, the real cost and the opportunity cost add up to make a persuasive argument for international diversification.

Mike Abbott is at Sable Wealth


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