International markets had a bumper year in 2019! The FTSE All-World index continued to rise by over a quarter, it’s best performance since 2009. The S&P 500 was up 30%, the NASDAQ by 35% and the Euro Stoxx 50 by 25%. After a poor 2018, China’s CSI 300 index rebounded, rising by a third during the year.
Despite continued geopolitical risks such as Brexit and the ongoing US-China trade wars, international markets delivered double digit returns in hard currency.
Astute investors who focused investments offshore and diversified risk from the local market were handsomely rewarded, beating inflation and achieving returns well above the JSE ALSI, for several years now.
Offshore investment, considered by investors as a key part of their investment strategies do so for several reasons:
1. Diversification – As the JSE ALSI represents less than 1% of global investment opportunities, investors who restrict their opportunity set to domestic assets miss out on more than 99% of available investment opportunities presented by listed assets around the globe.
Investing abroad provides accessibility to industries currently not available in South Africa (e.g.: information technology, biotechnology, electronics and pharmaceuticals to name a few). In addition to a much wider opportunity set, a preferred global equity benchmark, the MSCI All Country World Index, currently comprises of more than 2 500 investable companies compared to roughly 100 that drive the returns of the local market. Diversifying internationally allows for accessibility to growth regions benefitting from mega-drivers such as industrialisation, urbanisation, digital advances and growing consumerism.
All markets, including emerging markets, delivered strong USD returns in 2019. Over 1,3, 5 and 10 years almost all international markets leave SA trailing behind in both US Dollars and Rands.
Annualised USD returns
Source: Morningstar Direct
2. Optimisation – Studies on optimal SA portfolios recommend a minimum offshore allocation of 20% to 30% through the cycle for long-term investors, requiring a return of inflation plus 4% to 5% in rand terms.
This is a classic recommendation for retirement savers aiming to optimise outcomes for their future pension, restricted by regulation 28 of the Pension fund act. Investors with more global spending requirements, including a larger share of foreign currency denominated spending, or bequest motives (where multiple generations may live on different continents), can typically justify a larger offshore allocation.
Whatever strategic allocation range an investor deems to be appropriate, Brenthurst suggests an offshore allocation at the higher end of their appropriate strategic weighting, given the elevated level of economic and political risks facing South Africa at present.
3. Protection against declining purchasing power, due to the devaluation of the local currency over time. The rand is one of the most volatile emerging market currencies in the world and one of the main reasons foreign investment should be considered a long-term investment.
Many items in a consumer’s shopping basket from fuel to food to healthcare, are largely priced in foreign currencies as the inputs are either commodities, with prices struck in global markets, or heavily reliant on imported content. Viewed from this perspective, having adequate offshore exposure is merely a hedge against the long-term change in price of this part of a future shopping basket.
Episodes of currency weakness will more than likely remain a strong driver of price increases into the future. It is widely expected that the rand will continue to gradually weaken against all major international currencies, as has been experienced for several decades.
The rand over the last 20 years depreciated against the dollar on average by 4.24% per annum, with this longer-term trend expected to continue.
Source: Allan Gray
4. Lack of structural reform and political will. The issues of political uncertainty, corruption and lack of reform hindering the SA economy have dominated business news for several years. Although certain comments by economists and advisors are perceived to be negative or unpatriotic, the facts enable informed investment advice and decisions.
Most SA citizens remain hopeful of a recovery and although possible, unlikely immediately, considering the magnitude of South Africa’s woes. The economy is faltering, unemployment worsening, load shedding is expected to remain a regular feature, while SOE’s are bankrupt. State spending remains unabated, municipalities are teetering on the brink of collapse and there are no decisive measures to stop the deterioration of government finances. Unfortunately, the hope instilled in Cyril Ramaphosa’s cabinet has waned. The more time passes without definitive action, the less confidence this creates, and the impact on the local stock market evident for several years now.
Beyond adopting a longer-term offshore-focused strategy, it is important for investors to consider alternative local strategies for assets that may have been restricted to SA, such as pension, provident and retirement annuity funds and/or options for more conservative investors.
One such strategy for funds restricted by regulation 28, is to consider exposure to local income funds and maximise offshore allocation to 30% (within regulation 28 requirements).
Several income funds such as the Mi-Plan Enhanced Income, Counterpoint Enhanced Income, Coronation Strategic Income and Investec Diversified Income Funds have ALL beaten the JSE ALSI over one, three and five years at substantially lower risk.
Annualised returns over five years
Source: Allan Gray
Expectations for 2020
The World Bank recently cut its growth forecast to below 1% for SA, largely due to the highly detrimental impact of continued load shedding on the economy.
Stage 2 load shedding resurfaced early in 2020, well before most businesses and industries were back in full operation, expected to worsen as demand for electricity increases as companies reopen.
Persistent uncertainty and more aggressive load shedding levels will impact foreign direct investment, political and economic stability, employment and economic growth.
An unreliable power supply places an enormous constraint on the South African economy and will continue to deter both local and foreign investment, urgently required to alleviate unprecedented unemployment and reignite growth.
Economist Mike Schüssler of Economists.co.za reported about the magnitude of the South African challenges, compared to our emerging market peers earlier this year. He noted a decoupling of SA and other emerging markets, starting in 2013 and more significantly in 2015 after the firing of former Finance Minister, Nhlanhla Nene.
“If SA stayed with EM indices the JSE would have been valued R2.5 trillion higher now. Our pensions, investors etc suffered. A savings destruction.” he commented.
Although the JSE may be cheap based on historical valuations, it could remain subdued for longer on the back of lower expected earnings, considering the uncertainties regarding Eskom and the impact on growth and the economy.
Investors seeking insights on the outlook for the JSE ALSI that failed to keep pace with emerging market peers over the last 7 years and barely beating inflation are waiting to see how the ruling party addresses the first key event this quarter – The Budget and Eskom. With the World Bank lowering South Africa’s growth forecast below 1%, Moody’s rating call shortly after the budget, could set the tone for the local market in 2020.
Even Finance Minister Tito Mboweni is frustrated at the slow pace and lack of urgency required by government to implement structural reform, evident in a recent tweet:
If you cannot effect deep structural economic reforms, then game over! Stay as you are and you are down graded to Junck Status!! The consequences are dire. Your choice. Yep!! Askies!!
— Tito Mboweni (@tito_mboweni) January 10, 2020
The alarming debt situation at Eskom and other SOEs, a sluggish economy, poor growth, higher unemployment, lack of structural reform, expropriation without compensation, prescribed assets, water shortages, corruption, lack of consequences if any, and a potential downgrade will most likely continue to keep investor sentiment at all-time lows which won’t bode well for the local economy, stock market or the rand.
A global, flexible portfolio across all asset classes, including bonds, cash and equities – aligned with investors’ needs and risk tolerance – remains the most prudent approach for the year ahead.
The Brenthurst Global Equity and Brenthurst Global Balanced Funds delivered stellar USD returns, up 26% and 18% respectively over the last 12 months, while other international funds selected in Brenthurst’s global portfolios delivered in excess of 30%. More details here: Offshore investing