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[TOP INTERVIEW] Why one would invest outside of one’s home country

‘We have this disparity, even at an individual company level, between whether your investment represents domestic or foreign’: etfSA director Nerina Visser.

SIMON BROWN: I’m chatting now with Nerina Visser. She is, of course, a director at etfSA. Nerina, good morning. I appreciate your early morning time. We chatted, I think, exactly two weeks ago on an early Friday morning. We were talking then about Regulation 28 and offshore, and everything. That’s now been put to bed as the process happens. But as your last point of that conversation, as we were running out of time, you made the comment that you don’t want to be 100% offshore, anyway. And I thought, there’s the story. The point is that we kind of want to swing that, there’s a sense that everything must be invested in the US. From an investment strategy perspective that’s a horrible idea.

NERINA VISSER: Absolutely. So Simon, yes, when you think in terms of offshore investments, how much of your investments should be outside of your home country. And this is really sort of, I think, a prudent investment principle globally. It doesn’t really matter whether you are South African or whether you’re in the US for that matter. There are really two primary reasons why one would invest outside of your home country. The first one is what we refer to as asset-liability matching. In other words, if you have a liability and need for funds – whether income or capital – in another country from where you live, that's a very, very good reason to have it. What would be an example of that? Well, maybe you plan on living in another country. Maybe you travel somewhere else regularly. Maybe you want to have the opportunity for your children to study abroad. Whatever the reason might be for an income or capital requirements in another country, that is the primary reason. But the second one really relates to well-diversified portfolio management. So you are looking for diversification in markets outside your own, where you are in South Africa where the oft-quoted stat is that we represent less than 1% of the global investment opportunity set, it would be ludicrous to think that you’re going to allocate 100% of your assets to less than 1% of the world’s investible opportunity set. So there, for diversification, it certainly would make sense that you would want to have some of your assets offshore. And I guess then the question is, “Well, some – how much is some of your assets?”

SIMON BROWN: Is there a magic number? I suspect there’s not. From what you’re saying, this number is going to be dependent on the individual, their lifestyle, their life stage, and all those other sorts of questions.

NERINA VISSER: Exactly. It really is one of “it depends”. Now, I think what we often look at here is one of time horizon. I don’t want to talk about age, necessarily, but it really is about how long will it be before you need these funds in the other market. So, let’s say there is the liability-matching one. That’s relatively easy. You might know when it is that you want it, and then one matches it accordingly. And the shorter your time horizon, the closer you want the matching of your assets to your liabilities. But for many of us, and especially those that are maybe a bit younger than you and me, Simon, this is more about the long-term growth, the diversification strategy. Then the argument is very well made that it should be significantly more of your assets that would be held outside your home market. And, as your time horizon shortens, you will actually move towards actually getting more of your assets in your home market.

Now that necessarily brings us to the thinking around things like retirement funds and Regulation 28. And I think we find ourselves in quite a bizarre situation if you think of the way that our pre-retirement and post-retirement assets are managed, and all the regulations around them. In the pre-retirement phase – in other words, when you are still building up, saving towards the pot that’s going to become your asset base for your retirement years – you are restricted by Regulation 2018. So we have a situation where possibly a 25- or a 30-year-old has got at least a 30-year time horizon and is forced to have only 30% of their pension fund, the assets they are building up, offshore. That’s not appropriate.

But, on the other side, once you’re retired and you move into a post-retirement stage, you now move outside of Regulation 28 of the Pension Fund Act to the Long Term Insurance Act, which is the regulatory and legislative environment under which post-retirement savings are managed, and now you’re allowed to have 100% offshore. That's exactly the time when there should be much better matching of your assets to your liabilities. So you can appreciate why there really is a strong need at the moment for a review of our regulations, not just regulation of the Pension Funds Act, but I think just in general the prudency around how you ensure that you actually appropriately structure portfolios and manage assets for the purposes for which you are doing so.

SIMON BROWN: You’ve boggled my brain. I’d never thought of that. It’s the wrong way round in many senses. [Nerina chuckling.] I am sitting here with my jaw open. Part of it is that that look-through. I can go and buy Naspers, I can go and buy Richemont. We consider them local. But not many South Africans are buying overpriced Cartier watches. It is offshore, albeit it’s in zar. We can really go into the weeds here and get nuanced about it. But we can still get, even within those regulations, some offshore just in zar. And of course, there’s the ETFs as well, the 500 and the like.

NERINA VISSER: Yes, I think it’s also testimony to the extent of which the global investment opportunity set has become global. Exactly that. There are many, many companies that are multinational, operating in global jurisdictions. So the idea of the jurisdiction or the classification of a particular company or an investment according to a particular geographic region becomes a lot harder to understand. But that look- through principle is also going back a bit into the history behind it, and why that was introduced in 2011. That’s almost 10 years ago, so it also requires a rethink, I think. But, back in 2011 we had a situation where not too long after the global financial crisis in 2008, which you and listeners might very well recall, a big part of the 2008 global financial crisis was because of the subprime mortgages, sub-investment grade investments that were packaged together in single products that then got AAA ratings. That allowed many funds, including many pension funds, to invest in these package deals, if I can call them that. But of course, we knew that what was inside this AAA-rated paper was toxic. It was terrible. Fast forward into South Africa, to 2011, where there was a need for pension funds – or maybe the other way around – maybe it was the hedge funds that really wanted to have pension-fund money invest in them, and they started wrapping hedge funds in South Africa in structured products which banks issued. The reason I just started catching on to this and saying, no, no, no, was you cannot package one thing, make it something else, and now make it appropriate for a pension fund. And so they introduced the look-through principle to say it is not bank credit or a credit note that you are holding this, the pension fund. You are effectively holding a bunch of hedge funds in your underlying. And so this look-through principle was actually introduced for that reason, then also got applied in terms of how we determine foreign holdings.

Now, you referred to something like a Naspers, maybe, versus a global ETF. If I look at an MSCI world ETF listed on the JSE, it’ss relatively easy to argue that the underlying investments are all foreign stocks. So something that is classified as a domestic zar-traded instrument on the JSE doesn’t make it a domestic for the purposes of Regulation 28. But now one can argue exactly the same about a Naspers and many other companies on the JSE. I think part of what the Sarb wanted to do with this introduction of this excon [exchange control] change, which has now been suspended, but which is under review, is that they wanted to level the playing field also between the debt and the equity of the same company, for example. So we’ve got situations where the shares of a company may be classified as domestic because it’s listed on the JSE, but the debt issued by that same company, say an Anheuser-Busch or a Glencore, for example, could very well be a foreign debt because it is dollar-denominated or euro-denominated. And so we have this disparity, even at individual company level, between whether your investment represents domestic or foreign. I think it’s very good that we pause and just say, let’s take a step back and just assess what we are dealing with here, and how do we best actually apply this type of thinking to the different types of investment mandates, regulatory sort of frameworks and so on, because it’s much more than just Regulation 28. It does apply to Cisca, the Collective Investment Schemes Control Act, which governs unit trusts. It applies to insurance, to medical aid, and really across a very broad spectrum of types of investment mandates.

SIMON BROWN: Yes. And it starts to get complex. But, to the initial point, we need to be clever about it. We need to not chase returns. I know we look at our market not being much, we look at the Nasdaq and we think ooh, we want some of that. But I remind listeners that in the first decade of the century US markets went nowhere, and our rand strengthened by 50%. It’s not always green on the other side. We’ll leave that there. Nerina Visser, director at etfSA, I appreciate your time this morning.

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