JOHANNESBURG – What is going to happen to the rand? Should I move money offshore?
This is one of the most common questions investors and financial advisors pose to him, Pieter Hugo, managing director of Prudential Unit Trusts, says.
However, in answering this question, it is prudent to consider the broader market context. The currency is only one part of the equation, he argues.
The effective offshore exposure
The average local Balanced Fund currently has an offshore exposure of 26.6%. Regulation 28 of the Pension Funds Act caps the offshore allowance at 25%, but due to the significant depreciation of the currency, the current exposure is slightly higher. This is the typical offshore exposure a local investor’s retirement money would have, Hugo says.
An investor might consider the current challenges facing South Africa and argue that offshore exposure of 25% is not nearly enough. However, this percentage is not really reflective of the investor’s true global exposure, he says.
An analysis of the net asset value of the FTSE/JSE SA Listed Property Index (Sapy) suggests that about 30% of the Net Asset Value of the underlying properties are offshore, which could be used as a rough approximation of the revenue that these companies generate offshore. A similar examination of the FTSE/JSE All Share Index (Alsi) suggests that 56% of the revenue of all the listed companies included in the index is generated outside the country.
This means that the effective offshore exposure of the average Balanced Fund investor is almost 50%, he says.
Hugo says whether offshore exposure of around 50% is ideal, will depend on the investor’s personal circumstances.
Where should the rand be trading?
The graph below depicts the movement of the rand against the dollar over time (in red). Since South Africa has a much higher inflation rate than the US (the inflation differential), the rand should theoretically depreciate at a rate equal to the inflation differential. If investors take their money offshore they will receive roughly 2% interest in a US bank account (as opposed to the 7% they would have received in South Africa), but because the rand depreciates, investors are not “losing” money.
Sources: I-Net, Prudential Investment Managers
The rand peaked at R13.72 to the dollar late in 2001. Hugo says if the rand depreciated according to the inflation differential from that point onwards, it would have traded just below R23 to the dollar by the end of April this year. While it is quite a long way off from this, the current picture, is “still not fantastic”.
The pain South Africans are currently feeling is the currency’s movement from very expensive (in mid 2011) to very cheap in a short period of time.
While the rand should theoretically depreciate in line with the inflation differential over time, practically, it fluctuates around this path.
‘It’s not only about the rand’
Hugo says when investors ponder investing offshore the exchange rate is often their only consideration. But if you are moving money offshore, you are firstly selling a local asset, exchanging currency and then buying an offshore asset.
The graph below shows the real effective exchange rate when compared to a basket of currencies of South Africa’s trading partners (the black line). Above a level of 100, the currency is considered expensive. Below 100 it is cheap. The beige line depicts the price-to-book value of the MSCI ACWI Index, while the red line represents local equities.
Source: Bloomberg, Prudential Investment Managers
Hugo says if an investor had to sell South African equities and exchange rands for world currency to buy world equities, the investment returns on a three-year basis would not only be determined by exchange rate movements.
While the rand is currently very cheap compared to its own history, it is not the first time this has happened. It was also undervalued at the end of November 1985 and December 2001. In 1985, an investor would have sold South African equities at around fair value, would have sold rands very cheaply, but would also have bought offshore equities quite cheaply.
On balance, the investor made money on the trade. On a three-year basis, there was a 15% return when investing offshore at that time.
Fast forward to the end of 2001 and the same investor was selling South African equities fairly cheaply, selling rands cheaply and was buying very expensive offshore equities.
“You lost 120% [on a three-year basis] if you went offshore,” Hugo says.
At the moment, both local and offshore equities are marginally expensive, and investors should also keep this in mind when they decide to invest in stocks offshore.
“I’m not saying the rand can’t go either way. Just understand, it is not just about the rand.”