New foreign allocation limits for balanced funds

Moving money offshore does not always make sense – despite what many South Africans believe.

Warren Buhai

Senior Portfolio Manager,
STANLIB Multi-Asset

Brendan Howie

Senior Client Fund Manager

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The 5% increase in foreign allocations for institutions announced in the 2018 budget was welcome, but the STANLIB Multi-Asset team will continue to assess the right timing to increase the offshore exposure in its balanced portfolios and which asset classes represent the best opportunities.

Over the last 40 years a R100 investment in the local stock market measured by the Financial Times Stock Exchange (FTSE) in London and the JSE All Share Index (ALSI) would have returned 19.4% a year and would have grown to R120 829. The same R100 invested in offshore stock markets measured by the MSCI All Countries index (MSCI AC), would have returned 18% a year and grown to only R74 129.

So what is the opportunity in offshore stocks?
If you have any money in the local stock market, you are already highly exposed to offshore markets. South African and offshore equities are highly correlated. This is because:

The JSE is dominated by global companies, many of which do little if any business in SA. The five biggest listed stocks (with market cap in brackets) are: 1. Anheuser-Busch Inbev (R2.1trillion) 2. British American Tobacco (R1.6 trillion) 3. Naspers (R1.4 trillion) 4. Glencore (R850 billion) 5. Richemont (R550 billion)
All stocks are influenced by common factors such as sentiment, growth, inflation and interest rates. SA is an open economy so even SA-based businesses are exposed to these global factors

The following graph comparing rolling one-year returns from South African stocks (ALSI) and global stocks (MSCI), shows how the returns follow each other quite closely.

Rolling 1-year returns on ALSI and MSCI AC

So I don’t have to take money offshore to get exposure to global stocks?

True, but that limits your opportunity set to JSE-listed shares. This is both a poor basis for selection and often results in insufficiently diversified portfolios, as is apparent from the available South African stock index benchmarks. Naspers accounts for more than 20% of the ALSI 40 and the top five stocks make up 50% of the index. Capping methodologies have tried to address this but concentration risk remains high. Compare this to the market-cap weighted global opportunity set, as represented by the MSCI All Country World Index where the top stock, Apple, is less than 2% of the index.

Taking money offshore provides an opportunity to diversify away from the mega-cap stocks that just happen to be listed on the JSE. Offshore stocks are not a different asset class to SA stocks but they offer a better opportunity set.

We will be using the new offshore limits in the STANLIB balanced funds. The increased diversification reduces total portfolio risk and limits losses. Offshore investing is risky in the short-term, as periods of rand strength can be quite protracted. For this reason more conservative funds (such as STANLIB Balanced Cautious), that have an investment time horizon of up to five years, will not sit permanently at the new higher limits.

So are there any diversification opportunities across other asset classes?
Yes – global bonds and South African bonds offer vastly different return and risk profiles. They have some common drivers and some idiosyncratic factors that make South African bonds a unique asset class for rand-based investors. South African bonds are influenced by our Government’s creditworthiness, our political ups and downs and our local growth, inflation and interest rate dynamics. Local bonds may move in line with global trends, but often they do not.

In contrast, global developed market bonds often perform well when there is a crisis. In a crisis, money flows out of perceived risky assets such as equities, emerging market bonds and currencies into perceived safe havens such as US and Japanese treasuries. Global bonds represent a different opportunity for South African investors and are not simply an extension of the domestic bond market opportunity set. They have been important shock absorbers for South African investors in the past, and will continue to offer opportunities. The following graph shows the rolling one-year returns of South African bonds (ALBI) vs global bonds (JP Morgan Global Bond index), all in rands. Note the exceptional protection global bonds offered in the 2008 financial crisis, and the different patterns and extremes of returns in this period.

Rolling 1-year returns for the ALBI and JP Morgan Global Bond index

Offshore assets play an important role in balanced portfolios over time. For long periods you may not need them at all. But in times of turbulence they can behave very differently from local assets and provide vital shorter-term protection that is not evident when you look at long-term buy-andhold strategies. In the following chart you can see how the asset classes behave in different environments, and how offshore cash and bond holdings can offset losses from local equity markets in times of stress.

Diversification benefits of offshore cash and bonds

There is a perception that investors should take money offshore, even into cash, because the rand always weakens over time, but it’s not that simple. SA has its problems and the currency tends to weaken in the long run, but we have relatively high interest rates and returns on local assets have been good.

There will be many tactical opportunities to invest in global cash and bonds, but in general investors need to put their offshore assets to work and consider the timing of these investments. The increased opportunity set in global equities and other asset classes improves the drawdowns in balanced portfolio and protects wealth over time. In the active management of your investments, we will use the opportunity to invest more offshore when it is appropriate to access this wide opportunity set to diversify your asset returns, and minimise losses in turbulent times through unique offshore opportunities.