Navigating offshore investments in a world gone mad
Investors who took money offshore have enjoyed a great decade, with top-performing equity funds invested abroad returning average annual returns in excess of 15% a year in rand terms.
But asset managers say you shouldn’t expect the good times to continue because the start of the new decade looks very different to the start of the last one.
Pieter Koekemoer, head of personal investments at Coronation, says the past decade began after poor returns from equity markets and a short while after the global financial crisis.
While the recovery from the global financial crisis started in 2009, valuations (share prices relative to expected earnings) were still undemanding, he says.
Now conditions are very different, valuations are much more stretched and the outlook is more challenging than it was when the last decade started, Koekemoer says.
The past decade has been one of low interest rates, lots of easy monetary policies from central banks (quantitative easing), and many government bond yields are at negative yields.
It is difficult to see much more support coming from a monetary policy perspective that could help financial markets to move another leg up, he says.
The US enjoyed strong returns even at the end of the past decade, helped by significant corporate tax cuts, but this is also less likely to be repeated over the next decade, Koekemoer says.
“Equities remain where you want to be invested, as this is the asset class with the best probability of giving you reasonable return above inflation over the next decade, but we just don’t think returns will be as good as they were this past decade.”
Alex Tedder, Schroders chief investment officer of global and US equities, also cautions investors to expect lower returns.
After a 10-year period in which the S&P 500 has delivered a 250% total return (in dollars) and global equities have more than doubled, it seems reasonable to assume more modest returns from equities going forward, he says.
Tedder says volatility is likely to increase and stock selection will become more important as global uncertainty continues and the US bull market shows early signs of exhaustion.
Global growth slowed in 2019 and this trend is likely to continue as trade wars and political turmoil persist, he says.
Currency risk is significant and unpredictable and the rand can strengthen in the absence of positive local developments when other major currencies weakenSimbarashe Mangwiro, associate investment analyst at Morningstar Investment Management SA
Tedder says there is a wider-than-average disparity between sectors offering perceived safety and stability (such as utilities, real estate and consumer staples), and those exposed to global trade.
Simbarashe Mangwiro, associate investment analyst at Morningstar Investment Management SA, says offshore markets are not likely to collapse and could in fact move even higher.
But, he says, global market prices are now high relative to historical prices and this suggests they will, over time, move back to their mean or average prices.
If you buy in at current prices and the prices revert to their mean, it would lead to your investments losing value, Mangwiro says.
If prices do move higher first, the risk of losses would be heightened, he says.
Mangwiro says you should also consider the risks you face from having exposure to different geographies when you invest offshore.
For example, the currency tailwind you enjoy when the rand weakens can easily be a headwind when the rand strengthens, he says.
Currency risk is significant and unpredictable and the rand can strengthen in the absence of positive local developments when other major currencies weaken, Mangwiro says.
Koekemoer says you should remember that history does not necessarily repeat itself and you cannot merely extrapolate what has happened recently and expect more of the same.
It may feel very comfortable to invest in an S&P500 index-tracking fund right now, he says.
Morningstar reports that the S&P 500 including dividends and less withholding tax has returned 12.85% a year in US dollars for the decade to the end of 2019.
But Koekemoer says now you need a more diversified portfolio, and if you are tracking an index, choose one that is more global and not focused on the US only.
The MSCI World has a broader focus than the S&P 500, while the MSCI All Country World index (Acwi) has an even broader focus as it includes emerging markets.
Koekemoer says towards the end of the 2010s emerging markets moved out of bear territory and into a bull run, but valuations are still significantly below the highs of the 2000s. Hopefully, this will mean a better decade for investors in emerging markets and, as time goes by, indices such as the MSCI Acwi will be rebalanced more in favour of emerging markets, he says.
The decade to the end of 2019 was also a decade in which investments in global companies displaying the quality characteristics delivered the best returns for investors.
Companies with quality characteristics are those with low debt and stable earnings.
While you should expect lower returns from global markets than in the past decade, a more diversified portfolio offers you the best chance of earning good returns amid the current uncertaintiesPieter Koekemoer, head of personal investments at Coronation
Koekemoer says this favoured factor-based funds with a quality focus as well as managers who favour these shares, but nobody knows which shares will do well in the future.
As an active investor, Coronation is factor-agnostic as it picks stocks based on their individual characteristics.
Koekemoer says Coronation believes this is a more robust way to build a portfolio, though the bulk of 60-80 shares selected may end up being those that represent between 10 and 20 investment themes.
Tedder says amid the political and economic noise globally, Schroders believes global themes such as climate change, energy transition, sustainability, disruption and innovative health care will become more prevalent.
He suggests investors focus on a number of broad, long-term global themes that provide the best investment opportunities. In many cases these will be uncorrelated with traditional equity indices, he says.
Tedder says as an example, while the realities of rising global temperatures are rapidly becoming apparent to politicians and populations alike, the financial scale of the climate change problem is still hugely underestimated.
Mitigating greenhouse gas emissions will incur significant costs for governments, consumers and certain companies, while there may be a massive uplift for others focused on renewable energy, Tedder says.
Koekemoer says while you should expect lower returns from global markets than in the past decade, a more diversified portfolio offers you the best chance of earning good returns amid the current uncertainties.
Some uncorrelated exposures in your portfolios to assets such as precious metals can also help portfolios withstand tough periods and it is now possible to buy insurance at reasonable levels, he says.
Coronation is, however, still avoiding global bonds, as yields to maturity are low and unlikely to deliver inflation-beating returns.
While many South Africans are eager to invest offshore, Koekemoer and Mangwiro say deciding between offshore and local investments is not an either-or decision — a well-diversified portfolio includes local assets and you should not ditch all your local assets because the risks are significant.
Mangwiro says when these assets are completely out of favour, as local equities currently are, the best opportunities for future returns present themselves.