South African assets may be cheap, but that’s not a good enough reason not to invest offshore

By Mart Marie de Jongh, Certified Financial Planner at GraySwan  and Gregoire Theron, Chief Investment Officer

 The investment world’s fixation on global inflation and whether we are approaching the peak and heading towards a recession, has many investors sitting on cash, waiting for signals of a better market. Despite this, investing in South Africa presents a convincing opportunity.

In the South African Bond market, investors can yield more than 4% above South African inflation, one of the highest real yields compared to other developed and emerging markets.  This provides South African investors the opportunity to receive an income well above inflation with a lot of risks already priced into the asset class.

South African equities and emerging market equities are also trading at very low valuations not seen in roughly 20 years, offering a similar chance of investing in already very low-priced assets, with a high probability of generating inflation-beating returns in the future.

But while South African equities may be extremely cheap and bond yields high during these unsettling times of extraordinary interest rate increases across the globe, we believe it is essential for investors to diversify their investment portfolio by allocating into a range of asset classes, both local and offshore, which should serve as a safety net against the negative impact of inflation.

To further diversify portfolios, investors should look to allocate into assets that typically perform well during periods of US Dollar weakness, such as gold, commodities, and emerging markets. For example, investors can off-set their South African equity exposure by holding a similar basket of emerging market equities.

Having experienced a massive appreciation in the US Dollar due to developed market interest rate differentials, it is equally critical to monitor the US Dollar in this environment, as it is quite possibly approaching the end of its peak.

How much offshore is enough?

Due to the current opportunity set in South African income assets, a respectable offshore exposure would be between 25% and 35% for a retired investor with regular income requirements. This may change over time, as it will depend on relative real rates of bonds across the globe. For younger investors, where most of their assets could be invested in growth assets, a much higher allocation to global growth assets, specifically in equities, is recommended to diversify away from the South African stock market.

Importantly, offshore allocation is dependent on relative equity market valuations. The Johannesburg Stock Exchange (JSE) is trading at 20-year lows, and therefore we still see local opportunities, specifically in South African banks and cyclical stocks, such as mining. To off-set the concentration risk in the JSE, investors should look to allocate more money abroad, i.e. from 35% to 45% offshore exposure is optimal.

Keep a close eye on the Rand

The biggest risk for South African investors investing offshore is the Rand. As with most currencies globally, the Rand is very dependent on what happens with the USD. In our experience, South African investors tend to panic at the worst time and allocate their assets abroad during times of Rand weakness. Therefore, managing the currency and timing risk is critical.

As mentioned above, we may be getting closer to the end of the US Dollar peak and if the Dollar starts to weaken, the Rand will strengthen.  To manage this currency risk effectively, efficient derivative overlays within a portfolio can protect investors from Rand currency appreciation. At GraySwan, have we been utilising currency risk management hedging strategies for our clients, for over a decade, with great success.