The initial response to Finance Minister Enoch Godongwana’s 2022 Budget Speech was “boring but responsible” and “unsurprising”. However, tucked away on page 165 in Annexure F was one paragraph that did not even make the main speech.
Its content was unexpected and far from boring:
“The offshore limit for all insurance, retirement and savings funds is harmonised at 45% inclusive of the 10% African allowance. The previous limits were set at 30% and 40% for different investors.”
Up to now, very few investors had used much of their 10% African allowance so for most this provided the opportunity to increase their offshore portion by 50% – from 30% to 45%.
Considering all the pre-budget negative comments from social media around “prescribed assets” and “tax increases” this was a bold and positive move, which provides investors with a greater investment choice. It also sends a strong message that exchange controls for individuals are no longer a meaningful constraint.
These two sentences, which largely took the industry by surprise, have material implications for individual investors, trustees, financial advisers, and asset managers who need to carefully consider a few key issues.
What portion of my portfolio should I have strategically invested offshore?
The major benefit of increasing offshore exposure is access to a greater opportunity set and the ability to diversify more effectively. The domestic market consists of only 140 equity stocks which create both a stock and sector concentration risk. In contrast, the global market is made up of over 9000 stocks spread across regions, currencies, and sectors.
Most South Africans have 65% of their funds invested in domestic assets. This compares to South Africa’s weight in global indices which is about 0.5%. While nearly all global investors show some home bias, this ratio of 65% to 0.5% (or 130) is among the highest of any market. With all the known political, regional and currency risks South Africans are exposed to, it seems sensible to manage this home bias risk.
The counter argument is that most South African investors have future rand liabilities i.e., they need to pay future education, medical bills, food, rates, etc. in rands so they need to be cognisant of currency moves and the inherent volatility of the rand on their savings.
Top investment research specialists modelled over 100 years of asset class returns of portfolios with varying levels of offshore allocation to measure return and risk characteristics in different environments and over different measurement periods.
The conclusion was that the optimal strategic percentage depended largely on one’s timeframe and whether one was in a contributing (pre-retirement) or withdrawing (post-retirement) phase.
• For those with longer periods (retirement) the optimal portfolios were somewhere between 40% to 50% offshore while for those with shorter timeframes, the optimal portfolio was between 25%-30%.
• For those with very long timeframes (multi-generational) the optimal portfolio had more than 50% invested outside the country.
When should I tactically move towards this strategic allocation?
Once you have determined an optimal strategic allocation, it is important to consider when and at what pace to implement the change (specifically because this is a material single change).
Part of the decision is to acknowledge that timing is inherently difficult to get right so an approach may be to phase in over a period. The other consideration is to assess the current relative valuations of the currency and of both local and foreign asset classes. The rand, despite well publicised financial woes, credit-rating downgrades and the announcement of this relaxation has been relatively robust, strengthening 25% off the COVID-19 lows and in line with where it traded six years ago. Accordingly, it may appear as a reasonable time to increase offshore exposure.
On the other hand, South African assets, such as bonds and equities look cheap in comparison to many of their developed market peers. For example, real yields (nominal yield less inflation) in the US are about negative 5% while in South Africa they are positive 5%. While the extent of the gap is likely to be temporary, the difference is extreme. Similarly, using PE ratios as a crude valuation measure, US stocks (even after the recent pullback) are expensive on a historical basis and relative to South African stocks with a PE in the mid-20s almost double that of the South African market.
It is for these valuation reasons that many South African fund managers have indicated that they will not immediately make use of the full allowance as they see greater current opportunity in South African assets.
What are some of the other implications to consider?
Although the change in the offshore limit is a significant one for the South African investment industry, it is also positive because it provides greater investment freedom. With that increased freedom comes an increased responsibility to understand optimal strategic allocations, tactical timing decisions and exactly how one is going to implement.
There are also other knock-on impacts to consider. It is likely that over time, up to R500 billion could leave the South African industry to be invested overseas which may affect asset prices and many asset manager’s business models. It will put pressure on South African managers to improve their global capability as the portion invested globally in multi-asset portfolios has become a very material percentage. It is also likely that certain asset allocators (consultants and multi-managers) will increasingly use building blocks and employ global specialists, and this in turn may drive future product development.
Now you know that the commentators were wrong; the budget was in fact far from boring.
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