How much money should you have invested in foreign markets? It's the perennial question, but it's being asked with even more urgency now that the rand has strengthened against other major currencies and the government has announced an amnesty for grey money taken offshore illegally. We report on the conundrum.
When the rand was heading to R20 to the British pound, investors could not get their money offshore fast enough and those who already had a substantial amount in foreign climes, both legally and illegally, breathed a collective sigh of satisfaction. Then it all went very wrong. Foreign stock markets crashed and the rand strengthened dramatically. As a result, some people found that their foreign holdings had almost halved in value.
Many investors and their advisers saw foreign investment as the panacea for poorly performing local markets. Only two years ago, at least one high-profile financial adviser was telling people to invest everything offshore, without any qualification.
People who took this poor advice have been burned. Even those who followed a properly diversified investment plan, with only part of their investments offshore, have felt the pain.
The question now is whether to take more money offshore, return money to South Africa, or do nothing. And when it comes to returning money to South Africa, the government has announced an amnesty on grey money held illegally offshore, with the lure of just a five percent penalty on money over the R750 000 offshore allowance returned to South Africa, and 10 percent on any money greater than R750 000 left offshore.
John Green, the head of Investec Personal Investments, believes most investors approach the issue of how much to invest offshore from the wrong direction. He says conventional wisdom assumed that the rand would always continue to depreciate against developed countries' currencies, such as the dollar.
This made investment in offshore assets a no-brainer for many investors and financial advisers. The dramatic strengthening of the rand over the past six months and the significant shrinking in the rand value of local investors' offshore assets has, however, "shown that the no-brainer required some thought after all".
Assets and liabilities
Green says the unprecedented strengthening of the rand reaffirms the importance of one of the core functions of any financial planning exercise - that of matching your assets with your liabilities, particularly in so far as currency is concerned.
The most important issue you need to take into account is what he calls your future liabilities, or where you need to meet your future liabilities. In simple terms, where are you going to pay for things on which you will be living.
"It means your financial adviser, when giving advice, needs to take into account the currency that your future liabilities are going to be in. It should rate as one of the most important considerations, particularly after retirement.
"For example, investors planning to live in South Africa for most of their lives would have rand-based future liabilities," Green says.
As someone who lives in South Africa and plans to retire here, your approach to investment would be very different to, for example, someone who expected to eventually live outside of South Africa and to retire outside of South Africa, or to spend a large portion of their retirement outside of South Africa. Such a person's future liabilities would probably be largely dollar-based, or half-rand and half-dollar-based.
Green says over the past three to five years, many people acquired dollar-based assets to match rand-based liabilities, based on the view that the rand would depreciate over time in a manageable way and thus result in bankable rand growth in dollar-based assets.
"What they did not take into account was the significant element of risk inherent in such a strategy," Green says. "An analysis of the rand/dollar exchange rate over the past five years would reveal just how volatile it is. In fact, on a 12-month rolling basis, the volatility of the exchange rate has been as high as that of the index of the top 40 companies on the JSE Securities Exchange - the Alsi 40.
"The fundamental argument that in the long term the rand would depreciate because of the inflation differential [between South Africa and many developed countries, would only have been valid if firstly, the rand were historically a stable currency; and secondly, if investors were to get exposure to dollar assets at long-term rand/dollar exchange rate average values.
"The rand's erratic movements over recent months clearly negates the first point.
"As for the second point, it rarely happens that way. More often than not, investors buy dollars when the rand is either over- or undervalued relative to the median. Therefore, making investment decisions on the basis of devaluation is akin to timing the market, something that even the most experienced money managers struggle to get right."
Then, Green says, to overlay a foreign asset class like equities or bonds adds additional risk to the currency decision. He says if you have a rand-based liability outlook, you should approach any dollar-based investment with caution or scepticism and should not be excessively exposed to such investments.
"The crux is that you should understand your future liabilities, and depending on your appetite for risk, you should match your assets and future liabilities as closely as possible."
If you have a conservative outlook and are likely to have rand-based liabilities, Green says, you should consider more conservative investments that provide rand-based returns.
However, even if you have future rand-based liabilities, but you want more aggressive capital growth, you can consider investing in a dollar-based product. You should not, however, go in boots and all, but rather aim for the dollar-based investment to enhance the growth of the rand-based portfolio over time.
Other advisers say that it is also prudent to consider how much you are likely to spend in the future on imported items, such as motor vehicles, the prices of which will be determined by the exchange rate. Then you should, in effect, match your assets to your liabilities by having some assets invested offshore.
Green says there is no doubt the rand will weaken again and cause investors to run for the "cover" of dollar-based investments. "When this urge materialises, you should carefully consider your future liabilities and use dollar-based assets in this context," he says. "Using the exchange rate exposure for growth should be done in the same way as any other risky asset class - with caution and as part of a diversified portfolio."