CIARAN RYAN: Given the myriad challenges in South Africa, local investors might think investing offshore is a safer bet. However, some of South Africa’s largest investment managers have warmed up to domestic assets in the past few months, arguing that poor sentiment has created an opportunity too attractive to ignore. If that’s the case, how much should we be investing locally, and how much offshore – and where exactly is the value to be found locally?
Joining us to discuss this is the chief investment officer at PSG Wealth, Adriaan Pask. Hi, Adriaan. As concerns grow about the political and economic outlook for South Africa, local investors often assume that investing in offshore markets is a safer option than investing in the local market. How does South Africa’s investment landscape compare with that of the US now?
ADRIAAN PASK: Hi, Ciaran, and thanks for having me. Well, at this stage it looks like the US economy will continue to grow, largely thanks to masses of monetary and fiscal stimulus, which by now is known. The local economy and the other side of that equation are under severe strain. So, we are trapped in a dangerous chokehold of poverty, unemployment, and weak productivity.
The strengths of the economy, contrary to common belief, isn’t always the best proxy for future investment outcomes. If we look at the valuations now, for example, it seems like the valuations in the US are priced for perfection; so, a lot of that good news is already priced in, and we expect that the US counters will largely grow into their steep valuations – so not much in terms of reratings upwards and significant further gains from here.
In contrast to that, in South Africa things have been so tough over the last few years. [Even] leading up to Covid, we were in a tough predicament, so there really lies a big opportunity.
As you mentioned in your introduction, we start seeing investment managers locally identify that and say, well, if we look at the valuations we recognise the risks and the strains on the economy but, if you look at the valuations, there are significant opportunities in the local market.
CIARAN RYAN: You say economic strength is not always the best proxy for future investment outcomes. Now, for investors looking to take their funds offshore, what other factors should they be considering?
ADRIAAN PASK: Economic strength is one thing to consider, but valuations, as I said, are important now. So, the discrepancies between US and South African valuations are at extremely high levels. We see US valuations on some of the biggest stocks at record levels and, contrary to that, we’ve got South African stocks – should you exclude Naspers from the calculation – on single-digit multiples.
In addition to that, it’s not just valuation. Yes, economic strength plays a role, valuations play a role, but especially with offshore investing there are other practical things to consider as well. I mentioned Naspers and the concern there is that it is a substantial weighting in our local index; but that problem is far worse on the offshore index, on the S&P 500, where the top 10 stocks effectively account for 30% of the market capitalisation.
So obviously we need to be risk-aware too when we construct portfolios. It can’t just be opportunity-seeking. You’ve got to balance that against some of the risks out there. The level of, let’s call it domestic and offshore sector-concentration, needs to be considered as well. So where exactly are you going to invest your offshore funds? And, in addition to that, we are all aware of the practicalities of regulations; regulations that limit your ability to invest offshore.
But a counterbalance against that is obviously a tax incentive. There are significant tax incentives for local investments to keep in mind. And then the other factor is around transaction costs. It’s typically far more expensive to invest offshore than locally. Liquidity plays a big part in that, as well.
Briefly, back to the tax component of that, I think a component that’s often severely underestimated by investors is the amount of taxes that apply to estate duties in the event of your death. Obviously, the situation of offshore investments is significantly different to local, so, by the time that you’ve really considered how much offshore, it’s not so much just the typical argument that you would see around ‘Yes, but the economy here is poor and the economy in the US is fantastic’.
I’ve now mentioned valuations, risks, concentration, transaction costs, liquidity regulations – myriad things that need to also be taken into consideration.
CIARAN RYAN: Being exposed to only one currency can leave investors vulnerable to this concentration risk that you’ve just mentioned. How can they effectively mitigate that risk?
ADRIAAN PASK: That’s true. I think the same can also be said for investing in a specific asset class or in only one region, for example. I always think back on how sectors evolve. If you cast your mind back to the early 1900s, rail was effectively the biggest sector on the S&P. We know industries evolve and tech has come into play, and so on. Those things tend to move over time. So, the best protection that you ultimately have for that is diversification, just making sure that you’re not exposed to any specific asset class or any specific currency, sector, and the like.
CIARAN RYAN: You mentioned that exposure to diverse market sectors and geographies is key, but what is the appropriate percentage of one’s portfolio that should be invested in overseas assets?
ADRIAAN PASK: That’s a very good question, but unfortunately, I don’t think there is something like a one-size-fits-all recommendation here for specific clients. Each client has an individual set of circumstances – whether you potentially have existing liabilities offshore that you need to be able to cover, or whether you intend emigrating, for example. All those sorts of things come into play as well.
But I think what we can ultimately say is that offshore investing plays an important role in diversification, and your risk management on your portfolio. There are other factors – beyond economic factors – that you need to take into consideration; those things have been alluded to earlier.
If you look at it statistically, you would move around, say, 50% offshore, 50% local. That’s typically if you run a model to ask what will offer you the best risk-adjusted [allocation].
Obviously there are benefits that you pick up by taking capital offshore when the offshore component does well, and when the local one is suffering – and vice versa. That answer is typically 50:50. But when you start to adjust for what’s happening in your estate, for example, and what the tax consequences are for your estate, things might look significantly different.
Also, if you are a very cost-sensitive client, you might look at it differently. If you have a lot more capital in retirement funds where there are significant benefits but not much in terms of discretionary capital, then your portfolio would also look significantly different from that of someone who has a lot of discretionary capital that they can take offshore without being limited by our regulations.
CIARAN RYAN: We’re going to leave it there. That was Adriaan Pask, chief investment officer at PSG Wealth.
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