Some thoughts on investing offshore

Seema Dala, Allan Gray (Head of Orbis Global Client Servicing in South Africa. Orbis is Allan Gray’s partner) is one of the long standing clients of our office and I recently read an article compiled by her.

 If you want to know more about investing offshore – read more ………………

• Is the value of the rand important in your decision to invest offshore?

South African investors tend to race offshore when the rand weakens and offshore assets are doing well.  Your views on the relative value of the rand should however be just one of the factors in your decision to invest offshore.  Investors should also consider the diversification benefits of investing in global markets – the South African market represents just 1% of total world stock market capitalisation.  Increasing exposure to global markets, and to sectors that are underrepresented in the ALSI, serves to reduce portfolio risk over the long term.

The rand has continued to depreciate over the last 12 months, weakening by about 7% from R9.9/US$ to R10.6/US$. The extent of the rand weakness over the last few years (the rand was at R6.8/US$ three years ago) has not surprised us given the pressures on the currency, which include South Africa’s trade deficit and the resulting current account deficit, as well as our budget deficit.

In addition, the rand is susceptible to changes in foreign investor sentiment. We saw this play out in 2013 as our bond market sold off along with other emerging markets, largely due to concerns regarding the US Federal Reserve (the Fed) winding down its programme of quantitative easing. This, probably in combination with the poor SA economic fundamentals, caused the rand to weaken substantially.

 While it is difficult to say with certainty whether the currency will weaken or strengthen from these levels, particularly over the short term, we do think that there is a greater chance of further weakness as South Africa’s economic challenges make it vulnerable to a return to normal interest rates in the US, which may disrupt inward capital flows.

• Developed markets versus emerging markets: where are we finding value?

It is important to remember that bottom-up stock pickers like Allan Gray and Orbis invest clients’ money in shares of companies they think are undervalued irrespective of developments in an economy.

While developed market valuations are currently looking stretched, there are some sectors where, in Orbis’ view, the stock market is overly pessimistic about short-term developments. The media sector, for example, is a cyclical industry where the future is likely to resemble the past and the markets’ concerns may be resolved in the fullness of time.

In emerging markets, Orbis has been finding attractive opportunities in countries like Korea, Brazil, Russia and China, which have broadly underperformed their developed market peers and, based on our bottom-up research, a select number of companies appear to be trading at a discount to their intrinsic value. We recognise that opportunities in less-developed jurisdictions often come with a higher probability of negative surprises, and accordingly Orbis requires a greater margin of safety when investing. But in Orbis and Allan Gray’s view, the risk of losing money comes not from economic uncertainty or nervy sentiment, but from overpaying for investments – in that regard, the less you pay, the lower the risk.

•  Opportunities in AfricaFor an equity investor, the importance of short-term news and economic cycles is that these events create opportunities to buy companies for less than they are worth, as investors with short time horizons exit. The seemingly simple trick of long-term wealth creation is to invest consistently in assets that are trading at a discount to what they are worth and to avoid those trading at a premium. We think a number of these opportunities exist in Africa.

For example, Zimbabwe’s obvious risks give us the opportunity to invest in high-quality businesses at valuations that are unheard of in the rest of the world, with the possible exception of Russia. We believe that a total economic collapse is unlikely in Zimbabwe – however, should such an extreme scenario occur, we own quality industrial businesses with little debt that should retain some value.  If, rather than collapsing, the economy defies its critics and begins to recover or even remains stable, which is the more likely path from rock bottom, our investments should perform nicely.

The situation in Nigeria is very different as corporates are investing capital there to meet the expected demand from the growing consumer base.  Unfortunately, this can reduce returns for all players in a sector. A good example is the beer industry and Guinness Nigeria in particular. The highly rated Guinness has seen its return on capital fall from 40% in 2010 to 22% currently – still a very high number, but nonetheless a disappointment for investors. This is not to say we are not finding opportunities in Nigeria; we are. However, the risk of buying a company where earnings are unsustainably high because of temporarily weak competition is a much harder risk to identify than the plainly obvious risks in Zimbabwe.

• How to invest offshore

There are three ways to access offshore investments:

• Use rands to invest in rand-denominated unit trusts
• Use foreign currency to invest in foreign currency unit trusts via an offshore investment platform
• Go directly to the foreign manager

The first choice to make when investing offshore is whether you want to use a fund manager’s offshore allowance, or your own. Your choice depends mainly on whether you want to invest in rands or foreign currency and how much you wish to invest. 

If you value simplicity, and don’t particularly want to expatriate your assets, there are various rand-denominated offshore unit trusts available locally. The advantages of this route include relatively few administrative requirements and the fact that you don’t need to buy foreign currency or get tax clearance from SARS. However, these funds may close from time to time due to foreign capacity constraints.

If you want to expatriate your assets, or you prefer not to be restricted to the funds on offer in South Africa, the simplest route to invest in foreign currency offshore unit trusts is through an offshore platform operated locally.

Of course, you can also choose to go directly to individual offshore investment management companies, but the extensive range of choices can be confusing.

Using a locally operated offshore platform gives you options, and makes the selection more manageable. It also affords you a single point of contact, instead of having to deal with separate companies if you want to invest in funds from more than one asset manager. You are also able to switch between funds easily if your needs change.  It is worthwhile talking to your financial adviser about which unit trusts are the most suitable for you.

• How can you differentiate between offshore managers?

It is challenging to differentiate between investment managers. It pays off to gather as much information as possible upfront and to ensure that the evidence is relevant to future outcomes, not past returns. By looking at the business structure, the team stability, experience, breadth and evidence of past investment conviction and temperament, you can make a call on whether or not you think the manager will deliver consistently. These types of questions avoid the natural inclination of anchoring on past performance when it is the future that matters.

Of course most investors and advisers do not have the time, appetite or access to information to thoroughly research all funds or fund managers. Allan Gray has thus engaged independent ratings agency Fundhouse to rate the funds on its local and offshore platforms. Fundhouse is an independent, owner-managed financial services group, with a global research team and an extensive evidence-gathering process. They apply a bespoke, qualitative approach to fund ratings. The team analyses each fund manager, looking at the business and shareholders, the investment edge and process, the experience of the team, their decision-making skills and past investment actions. They gather detailed evidence by engaging in face-to-face interviews with investment teams and conducting due diligences. Analysts collate as much information as possible to ensure that the evidence is relevant to future outcomes and not based on past returns. At the end of this process a rating is assigned to each fund.

Fund ratings add an extra layer of assurance in the decision-making process and go some way to assisting investors and their advisers to make the right long-term choices.

You can contact Seema at seema.dala@allangray.co.za