Whenever there is elevated political risk in South Africa (think Nenegate and now Phala Phala) South Africans want to get as much of their savings offshore as possible. After the changes to Regulation 28 this year it is now permissible to hold 45% of retirement savings in offshore investments, a significant increase on the 30% previously allowed. But South African asset managers have been slow to take advantage of those increased allowances.
Talking to Michael Avery on Not The Daily News on Fine Music Radio, Eddy explained how additional volatility introduced by the rand could more than reverse the benefits of the additional diversification that offshore offered.
“When the limit was 30%, everyone was clamouring for higher maximums and wanting to maximise offshore exposure. With the move to 45%, we have seen that most mandates are sitting at 30 to 35% and not maximising the new allowance,” said Eddy.
Noting that how much an investor holds offshore was a “key, long-term structural decision”, Eddy pointed out that when investing offshore there were two components that contributed to returns and volatility: the underlying asset itself i.e., the return to the stock or the bond in offshore hard currency, and the return of the currency itself. Sometimes these two components offset each other, sometimes they augment each other.
“The greater volatility introduced by the currency component is one of the main reasons many mandates have been hesitant to take full advantage of the full 45% offshore exposure,” said Eddy. “After all, we are talking about South African investors with investment goals in rands measured against SA inflation.”
He said the rationale for global exposure was quite clear. Diversification is a key component of successful long-term investing and within the South African market, which makes up less than half a percent of global exposure, there is limited capacity to diversify.
“We have got a somewhat limited universe of liquid shares, about 80-100 that are tradeable. There is concentration in sectors like resources and financials, and a couple of large single exposures, such as Naspers and Richemont. When you compare that with a global investment universe, proxied by the MSCI World with more than 1,600 shares invested across 23 countries, it might seem like a no-brainer to maximise offshore exposure,” Eddy said.
“But for rand-based investors, offshore investments diversify to a point and then the currency differential introduces more volatility that is unrewarded. Effectively, the additional volatility that the currency introduces limits one’s ability to benefit from that maximum global diversification framework.”
The rand is impacted by both global factors and local factors, leading to significant volatility, with large selloffs followed by strong rallies. Investors’ responses, which Avery noted can amount to “own-goals”, were often knee-jerk reactions at the worst possible times.
Looking at the rand on a rolling 12-month basis over the last 27 years, the currency has sold off more than 20% in a year more than 18 times, with the biggest depreciation being close to 60% (in 2001). Over the same period, it has strengthened by more than 15% more than 11 times.
Eddy said: “Yes, the rand is very volatile, with big peaks and reversals around times of market stress, like 2001, 2008, 2015 and 2020. But we often look at how the rand has depreciated in isolation and we don’t consider the relative interest rates of each country.”
At the end of June 1995, for example, the rand traded at R3.65 against the dollar; this week it traded around R17.17. That is the massive depreciation at a headline level that everyone talks about, but that is not to say that investors have taken the equivalent hit to their savings. In fact, said Eddy, “a rand deposit has actually outperformed a dollar deposit in rands terms over long-term”.
He gives an example: R100 invested in a South African 3-month deposit in 1995 would have grown to R928, whereas R100 invested in a 3-month US deposit would have grown to only R831. “So the relative interest rates have compensated South African investors for the depreciation in the rand.”
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