YOU PROBABLY HAVE MORE OFFSHORE EXPOSURE IN YOUR INVESTMENTS THAN YOU REALISE
South Africans are famous for our resilience. We tend to produce our best efforts when the odds are stacked against us however at the moment, with all the bad news about the government, it feels that even this well-known resilience stands no chance. The phrase “failed state” is used with increasing regularity and through the haze of corruption, cadre deployment, poor economic policy and little or no accountability it is difficult to see how it will all get remedied. Many investors are looking at their investments and wondering what impact poor economic performance could have on them. Fortunately, however, as we discuss in this month’s Financial View, you may already have more exposure to offshore markets than you realise.
Due to the tax advantages within the products many of us have the bulk of our investment assets within some form of retirement savings product, whether that be within a pension fund, a provident fund, preservation funds or personal retirement annuities. With the majority of our assets within the retirement space it is important to consider where fund managers typically invest your funds. All retirement savings products are governed by the Pensions Fund Act, this means that all funds need to comply with Regulation 28 (“Reg28”) of the Act. The Act sets Prudential Investment Guidelines of “PIGS” and provides strict investment limits to asset classes and to individual securities. Reg 28 is a double-edged sword as whilst it ensures good portfolio construction due to the diversification it provides, it also may prevent appropriate exposure to specific assets that have higher growth prospects.
Amongst the limits that Reg 28 includes is a portfolio limit on how much of the portfolio is invested in equities. A further limit deals with how much of the assets of the portfolio can be based directly offshore. This offshore limit has long been a bone of contention in the financial advice community as previously it seemed relatively restrictive. Over the years, small occasional changes in this offshore limit have been introduced, however, the South African Reserve Bank announced a meaningful amendment to this limit just before last year’s Budget Speech. The big announcement was that the direct offshore limit had been increased to 45% from the previous level of 30%. This was an effective increase of 50% of how much you could have invested directly offshore in your retirement savings.
The response of asset managers
We are now a year and a half down the road since the large increase (and in effect relaxation) of the offshore limits. We decided to see what asset managers have done and take a look at the asset allocation of the ten largest balanced funds in the country. Balanced funds are designed to comply with Reg 28, so these funds are now able to invest up to the new 45% level.
On the chart above, we have used the columns to demonstrate the percentage of their assets that are defined as offshore assets according to their last monthly fund fact sheets. The two horizontal lines represent the new Reg 28 offshore limit of 45% and the previous limit of 30%. What is clear to see is that every single of the asset managers increased their offshore allocation since the law amendment in February 2022. Some like Coronation Balanced Plus Fund and Ninety-One Managed Fund have maxed out their offshore exposure as much as they can.
The chart demonstrates that typically your retirement savings will average between 35% and 40% held directly offshore. This direct offshore holding has no link to the performance of the South African economy at all.
What about the other 55%?
Reg 28 says you can have no more than 45% invested offshore which means conversely you can have no less than 55% invested in South African assets. For the investor though this just gives opportunity to even further offshore exposure. There are a number of companies listed on the Johannesburg Stock Exchange (“JSE”) that have very small links to the South African economy. This may be because the bulk of their client base is global, or their product is priced in hard currency, or that they derive their value themselves from overseas investments. These shares are called Rand-hedges and investing in them gives you exposure to offshore markets and protection against any Rand weakness.
If one looks at the largest constituents of the JSE Top 40 it demonstrates just how the Rand-hedges dominate the JSE. The JSE Top 40 is an index that consists of the largest 40 companies ranked by investable market value in the FTSE/JSE All-Share Index. Investable market value is important as a consideration as some companies such as BHP Billiton may be huge but only a limited number of their shares are listed on the JSE.
The ten largest constituents comprise 55% of the index so it is a good sample to assess. Even within this sample there is a further dominance with the two largest companies substantially larger than the rest.
Anglo American is the largest company within the index, accounting for 11.21% of the entire JSE Top 40 index. Anglo American is a global diversified miner with limited operations within South Africa. As a miner the price of their products are normally priced in US Dollars so any weakening in the Rand benefits their revenues and their bottom line or profit.
Naspers and Prosus are companies in the same stable with complicated cross holdings that are starting to be unwound. They have a combined 15.01% weight in the index. The value of these businesses is less than the value of their shareholding in Tencent – a large Chinese technology giant. Their South African operations (such as Media24) add no value to their market capitalisation.
Firstrand and Standard Bank are the sole banks within the top 10. They are fully exposed to the South African economy even though they have some operations overseas. For the purposes of this discussion, we will call them part of SA Inc with no Rand-hedge qualities.
As we continue through the list, we can easily identify further companies with Rand-hedge qualities. MTN has large operations in Nigeria, Ghana & Iran. Gold Fields, similar to Anglo, has mines across the world with their products priced in Dollars. Richemont is a luxury goods brand with the bulk of their markets in Asia and Europe. British American Tobacco sells cigarettes across the world. Mondi, despite their recent sale of their Russian operations, still maintains plants around the world.
We have eliminated the banks and even if we say the rest of the companies (excluding Naspers & Prosus) have 20% of their operations somehow linked to the South African economy we see that 69% of the JSE will provide a hedge against the weakening Rand.
Conclusion
If we consider the fact that in your retirement savings you have an increased percentage invested directly offshore, and that the local investments are predominantly delinked from the South African economy it is realistic to say that currently around 65% of your investment portfolio is already protecting you against South Africa’s many known weaknesses.
We acknowledge that not everyone can afford to save and invest any more than they are already doing however we think investors can do so with the reassurance that they are receiving a tax break on their contributions to their retirement funds and that their investments are still giving them a high level of protection. We think that the increased offshore exposure is a positive move and will help people saving for retirement achieve their goals.
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