Make sure the grass of offshore stocks is truly lush and greener
While most South African investors tend to focus on whether they have adequate exposure to offshore assets in terms of quantity, less is heard about the quality of those offshore holdings.
Here I define "high quality" in terms of the ability to attain excellent risk diversification, as well as to access the best possible opportunities for maximising your returns. Both of these are key ingredients for building a robust investment portfolio.
Adding global investments to a portfolio has been widely shown to meaningfully reduce that portfolio’s risk characteristics without detracting from returns, helping to create an "optimal" portfolio when considering risk versus return.
Thus it is somewhat surprising that, according to an IMF survey, most equity investors around the world are overweight in their own home market. Those in many emerging markets such as Turkey, Mexico, India and Russia have nearly 100% of their equity portfolios invested at home, while US and Japanese investors have about 75% in domestic equity.
Investors in only a handful of smaller and more open markets, such as Singapore, Austria, the Netherlands and Portugal, have kept less than 50% at home. In SA, the survey showed domestic equity exposure at an average weighting of about 80%.
Excessive domestic exposure can certainly pose problems for investors because even large and well-diversified equity markets can experience long poor performance. For example, between 2000 and 2013, the US’s S&P 500 Index was basically flat. In Japan, returns from the Nikkei 225 Index were close to zero for 31 years between 1986 and 2017. And our own equity market has traded sideways for well over three years now, causing anxiety among South African investors.
Extended periods of low returns can have a serious effect on individuals’ longer-term retirement savings, especially for those nearing retirement or who have just retired.
Being overexposed to your home market can also be of concern if the quality of the offshore diversification it offers (via local companies’ offshore earnings) is poor. When examining the companies listed on the JSE compared to global equity markets — represented by the MSCI All Country World Index (ACWI) — we see that the FTSE/JSE All Share Index (ALSI) offers a very different set of opportunities from the ACWI.
ALSI investors are very underexposed to both the Americas (comprising an estimated 6% of earnings versus 42% in the ACWI) and Asia-Pacific (20% versus 33%). Yet these regions encompass the world’s biggest capital markets and some of the world’s largest and fastest growing companies.
And the ALSI’s higher exposure to SA and other African equity markets makes investor portfolios more susceptible to emerging market volatility.
SA’s investors lack choice when it comes to diversification within and across many sectors. The graph illustrates this, with the rapidly expanding technology sector offering only three small companies (plus Naspers, which is actually included in Consumer Services), while the ACWI has 252 tech companies with global giants such as Alibaba, Apple and Facebook. In energy, the ALSI has Sasol (the only option), but the ACWI can offer the likes of Shell, Chevron and Repsol, as well as renewable energy companies.
And let’s not forget popular consumer brands that aren’t available locally, such as Coca-Cola (one of Warren Buffett’s long-term favourites), Heineken and Nestlé. By contrast, ALSI investors are overexposed to the volatile basic materials sector. This makes up nearly 52% of offshore earnings of ALSI-listed companies compared with the ACWI’s 21%.
And although the ALSI does offer an impressively broad selection of mining and commodity firms, over the past 10 years, the FTSE/JSE Africa Basic Materials Index has returned 0%. Contrast this with the 18.1% return by the MSCI World Information Technology Index over the same period, and it’s easy to see that the ALSI does not offer the most optimal opportunities for SA’s investors.
The higher-risk nature of the JSE and narrowness of options in the South African market are important when determining how to achieve a high-quality offshore portfolio. Once you have determined the appropriate quantity of offshore exposure, you should think closely about quality, because although globalisation has helped to improve the global quality of JSE-listed companies, they still cannot match the innumerable possibilities for higher return out in the rest of the world.
• Hugo is MD of Prudential Unit Trusts.