Portfolio diversification key to avoid boom-bust cycles from offshore investing

Investing offshore has been beneficial for SA investors for a number of years, partly because of the rand weakness, but more importantly because global equities delivered phenomenal returns. 

Global equities returned 7% per year in US dollars over the last seven years and 11.5% once rand weakness is accounted for. This is in contrast to the performance experience of SA equities, which delivered average annualised returns of only 4.6%, negative in real terms after accounting for the 4.9% inflation rate over the same period. 

The outcome from global equities is not surprising given the US market, a large component of the global equity index, experienced one of the longest bull markets in history, supported in part by accommodative fiscal and monetary policies. On the other hand, the rest of the developed world, alongside emerging markets, has struggled to keep pace with the US over the last decade. 

However, the last six months to June 2022 have been challenging for developed-market equities, with the broader MSCI World index losing 21% in US dollars. The sell-off was driven by a myriad of factors, including higher and more persistent inflationary pressures, worsened by geopolitical events, more aggressive interest-rate hikes and a slower growth path for global economies. 

Don’t chase performance

The decision to invest a component of your savings outside SA should not be driven by a desire to chase performance, but rather by the need to achieve portfolio diversification. By investing offshore, SA investors have an opportunity to diversify away from a small and concentrated local market and gain exposure to a broader global universe of investible companies. 

This allows investors to capitalise on circumstances that are different to those in the local space — investing in innovative companies with disruptive business models, such as the tech giants in the US, or companies that continue to do well in emerging economies that are reform orientated and therefore experience faster economic growth, such as India.

These opportunities can provide a buffer against local markets, and they have certainly done so for the better part of the last decade. 

But gaining exposure to these different areas of global markets does not come without risks and valuations are an important consideration, especially during times of deep market stress, when quality of business fundamentals becomes top of mind for investors. 

For example, at the end of June 2022, US tech companies had sold off some 31% in US dollars since their peak in November 2021, as their rich valuations became vulnerable in light of rising interest rates and lower growth expectations in the US. 

It’s important to remember that risks present in different ways and diversification allows investors to spread their portfolios’ sources of risk and performance drivers. Old Mutual Multi-Managers (OMM) understands and appreciates the benefits of having exposure to different drivers of performance. 

In our portfolio construction process, we give due consideration to asset managers’ investment styles to ensure a combination of complementary investment approaches. This acts as a risk-mitigation tool by reducing the risk of over-concentration to certain areas of the market. Over-concentration increases the chances of a negative-performance shock to a portfolio should there be a drastic change in the prevailing market environment. 

This is evident when comparing the performance of our value-orientated global equity managers to their growth counterparts during the first six months of 2022, relative to their experience over the last four years. 

Value managers have struggled over the last decade, and particularly over the last four years, given their lack of exposure to areas of high growth, such as US tech companies. However, as the market environment transitioned to account for a less accommodative monetary-policy stance, areas of high growth that traded at lofty valuations sold off this year to a much larger extent when compared to cheaper areas of the market, such as the financials, energy and materials sectors. 

A balanced exposure to both investment styles translated into a smoother ride for the end investor. Similarly, investors who opted to only gain exposure to previously winning global asset classes, such as global equities, would have seen the negative impact of the market sell-off over the last six months on their overall wealth, while a more diversified approach could have improved this outcome.  

Diversification is key

Diversification helps avoid boom-bust scenarios that can easily influence the wrong type of investor behaviour, typically eroding investment returns and increasing the risk of not meeting investment goals. Building a diversified portfolio of various asset classes and asset managers, which aims to deliver on specific client objectives, is the preferred approach to weather most market and economic environments. Regardless of the prevailing market environment, remaining invested and staying committed to a clearly defined investment strategy improves the chances of a successful outcome over the investment horizon.

Old Mutual Multi-Managers (OMM)

OMM offers investments that blend the best of SA and offshore asset managers. It manages multi-asset class funds that target inflation plus returns and are aligned to the investor’s investment targets or required returns. OMM blends asset classes together to achieve the target objectives, and then selects the best fund managers in the industry to implement its asset allocation decision. OMM monitors the asset-class and asset-manager performances over the short to medium term and makes changes where necessary, following a rigorous and repeatable investment process. 

For more information, visit: www.ommultimanagers.co.za 

This article was paid for by Old Mutual Multi-Managers (OMM).