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Kim Kardashian and the unpredictable rand

Investing offshore should be done for the right reasons.

If, at the start of 2017, we had been told that Pravin Gordhan would be fired, that both S&P and Fitch would downgrade South Africa’s credit rating and that Brian Molefe would be reinstated as Eskom CEO, what would we have expected of the rand? Given those variables, most people would surely have bet against the local currency.

Yet five months into the year, and with all that having happened, the rand is stronger today than it was when we were lighting our New Year’s fireworks. As Tamryn Lamb, head of Orbis client servicing at Allan Gray, points out, this highlights just how difficult it is to predict the local currency.

“What’s been driving the rand is not what’s been dominating our minds in South Africa every day,” she says. “It’s that global investors have been more comfortable with investing in emerging markets, which include South Africa.”

Lamb argues that there is an important lesson in this.

While local online searches following the cabinet reshuffle in March were dominated by topics such as Malusi Gigaba, downgrades and Zuma must fall, on a global scale these issues were dwarfed by searches for Obamacare. But even that paled in comparison to internet users searching for Kim Kardashian.

“People globally are, relatively speaking, not as interested in what’s happening in South Africa,” says Lamb. “While we are all focusing on these history changing events, global search engine interest is far more concerned about a reality television star.”

This is significant because many local investors allow political news and day-to-day movements in the rand to influence their decisions about whether or not to invest offshore. This leads to attempts to time investments based on the currency, but Lamb argues that this is the wrong approach.

“We think investors should start by deciding how much of their portfolio they should put offshore,” she says. “They should make that a long-term objective, then work towards achieving it over an extended time frame and at a regular pace.”

How much should I invest offshore?

When working out what portion of your wealth should be invested outside of the country, Lamb says there are two things to take into consideration. The first is the need to protect your local purchasing power, and the second is diversification.

Even if you live in South Africa and your spending is entirely in rands, many of the goods and services you buy are really priced in dollars or other currencies. This includes the likes of imported electronics, fuel, vehicles and even clothing.

“When we think about what we all spend on a day-to-day basis, at least a third of what we buy is denominated in currencies other than the rand,” says Lamb. “So you should consider having at least that amount offshore.”

However, for the sake of diversification, you may want to invest even more than that outside of South Africa. This is because there is a far greater opportunity internationally than in the local market.

“The South African stock market represents only 4% or 5% of the global emerging market universe and less than 1% of the world opportunity set,” Lamb explains.

Investing offshore should therefore be part of any long-term plan, she argues. And the best way to approach this is to make regular contributions into funds with an international focus, or which have meaningful international exposure.

“Firstly, this means you will be able to smooth out rand volatility,” she says. “And secondly, if you attempt to time the rand you may be missing out on what’s happening on the other side – which is that you are giving money to a manager trying to create wealth over the long term.”

That creation of wealth is not only dependent on where the rand goes, but on many other factors including the valuations of the underlying assets. And investing purely on currency movements means that you may miss out on those opportunities.

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Diversifying based on how one’s expenses are linked to Rand devaluation seems reasonable. One should probably do that and then some to mitigate risk. Over 5 years returns on an offshore equity fund plus rand devaluation are about the same as local equity funds (although a component of local funds is of course exchange indexed). That seems like a good deal for the risk mitigated.
Linking the currency to local events unless these are absolultey seismic is very tenuous. Remember how fluctations in the rand in the 90’s were frequently blamed on Mugabe. One lesson though, is that emerging market currencies devalue progressively due to interest rate differentials over many years but can then fall dramatically very quickly – looking at Nigeria, Zimbabwe, Venezuela and other parts of South America as examples. When that happens currency controls come very soon afterward and with very limited warning. The same thing applied in SA with the Financial Rand in the 80s. That may imply that one shouldn’t necessarily regard local rand hedge counters as sufficient mitigation. Keep in mind that most of one’s pension assets have very limited offshore exposure (beyond local rand hedge counters) due to Reg 28.

Non-resident institutional units transacting with resident institutional units are grouped into the
foreign sector or the rest of the world. The classification of the foreign sector is based on the
distinction between residents and non-residents. The concept of residency is based on the
centre of economic interest and not on nationality or purely legal criteria. An institutional unit
is considered to be a resident of a country when it has an economic interest in a country, that
is, when it has a location (dwelling or premises) within the economic territory of a country from
where it intends to engage indefinitely or over a finite but lengthy period of time (longer than a
year) in economic activity on a significant scale. The economic territory of a country consists of
the geographic territory administered by government within which persons, goods and capital
move freely inclusive of airspace, territorial waters and enclaves.
An institutional unit or enterprise is therefore a resident of the Republic of South Africa when
it has an economic interest in South Africa, that is, when it has premises within the economic
territory of South Africa from where it engages or intends to engage indefinitely or over a finite
but lengthy period of time in significant economic activity in South Africa. The foreign sector
or non-residents could similarly be defined as institutional units or enterprises with a centre of
economic interest outside the borders of the Republic of South Africa.
Branches and subsidiaries of foreign enterprises domiciled in South Africa are therefore
classified as resident institutional units. In this instance, the foreign enterprise or non-resident
owner is classified as part of the foreign sector, while the foreign-owned subsidiary or branch
is classified as a South African resident. By contrast, branches and subsidiaries of South
African companies domiciled in the rest of world are classified as non-resident or part of the
foreign sector.

I have a question regarding this. If diversification is key, and the only way to have steady, measured growth- then we should all hold alternative investments, property, cash, bonds etc. If this was so then shouldnt the only ETF we have in our portfolio be DBX WorldMSCI or similar?

Maybe because your risk profile is not the same as the next guy’s. He might be more interested in smart beta and all that. And DBX is quite expensive TER-wise. Plus, since capital gains tax is more of an inflation tax anyway, it would probably be cheaper to rather open a foreign account and buy a similar thing with dollars.

Other than that, I agree DBXWD or CSP500 is probably the best and easiest options for a teenager or young adult that’s just starting out.

End of comments.

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