• ETF Enthusiast

Expand your investments past the 1% Economy

Investing is a long-term commitment and in these times a non-negotiable to ensure that you can live comfortably and build wealth to the benefit of your family.

In this article, I want to talk about one of the most important choices involved your investment decision-making process, and that is how you structure your investment portfolio based on location.

Our natural biases

Everything which leads us up to this point in our lives has gradually built up our unique perspectives of the world. These unique perspectives build up biases in our mind which play out in every way in which we live and make decisions. A simple example that I have noticed I often do myself is when watching a debate or conversation between two opposing views I will automatically lean to one side of the debate from the start and I will double down on this side of the debate without taking a naturally neutral stance to hear all sides of the discussion. This is called confirmation bias. I look for information or arguments which confirm my current belief systems which strengthens my conviction in that belief system.

Biases come through in our money too, working for a company owned by Steinhoff international I have seen firsthand how many young ambitious colleagues thought that buying shares in Steinhoff was a good move since they have a tangible impact on the financial performance of the company. As a result, I now have firsthand experience as to how disastrous this can be. Not only investments were erased but the confidence that you were going to have an income in the future was too. A double whammy. We often frame our world according to our professional capacity at the expense of a more balanced view. Just because you understand the business you work for doesn’t necessarily make it the best place to put your money.

As South Africans when thinking of investing, it is often our natural bias to think of what is available to us in South Africa. Most fund managers will present you with an array of local fund options, largely driven by legislation from the South African government which limits offshore investment contributions for retirement products in the form of Regulation 28. The desire for fund managers to pursue the lucrative contracts of retirement portfolios for large corporates have encouraged them to put a large number of resources behind these funds. These factors all mean that there is a large local bias built into the financial system.

I want to make an argument that local investment should be our final thought process when looking at where to invest and not our first.

Structurally overweight

As a South African citizen, it is natural that most of your assets are dependent on the local economy. If you own a house, the ability to gain an income from that asset is based on the rental market of that neighbourhood, you are paid in local currency and your ability to sell that asset is dependent on the liquidity of the local market. If you own a car, all you can get in return for selling it is likely some South African Rands.

Due to regulation 28 it is structurally designed so that most of your long-term retirement investments are based in local currency and on South African businesses. This can often be the only form of share investments that many people make in their lives. If the decision was made to add local investments from the shares listed on the JSE, we would just be duplicating the existing companies we are already invested in and concentrating our risk even further.

Our first thought process should involve a complete understanding of our full financial picture, understanding where our assets are based and what currency impact them and from there determining the most appropriate investment so that the wide array of the world’s economic opportunities are capitalized on and duplication and concentration risks are minimized.

South Africa’s contribution to the world

Less than 0.5% of world economy

The world is an ever-moving economic machine. If you have ever looked at the world GDP meter at https://www.worldometers.info/gdp/ you will see the ever moving GDP figures as the world is constantly economically active.

Each country produces their share of this data, and last year in 35th place South Africa contributed $358bn to the $86 265bn a mere 0.41% contribution.

If you are concentrating your investments to South Africa you are limiting yourself to a tiny investable portion of the world. Over the last decade it has become increasing evident that this is increasing your level of risk significantly without giving you’re the appropriate returns.

A 1% currency

Most South African’s are likely earning their income in the local ZAR. The ZAR although a strong force on the African continent is only a tiny fraction on the world’s currency transactions and due to the long-term depreciation of the rand the buying power of what it brings you in the world has been diminishing.

I am someone who wants to travel and see the world, especially when no longer working full time one day. This means that if everything I earn, own and invest in is concentrated on one currency, the power of my assets compared to the rest of the world is diminishing at a compounded rate and therefore so is my ability to travel and live in other countries.

I don’t tend to have any short-term opinions on the strength or weakness of the rand, however this long-term view is based on the change in many experts opinions on the fair value of the rand over the last few years, as well as the long-term difference in inflation in South Africa versus the rest of the developed world which has strongly correlated with currency depreciation.

Investing offshore allows you to capitalise on the wide array of the worlds economic opportunities and moves you away from being a niche one market investor with all their eggs in one basket.

Methods of investing offshore

There are essentially three versions of offshore investments, level 3 being offshore investing in its truest form:

Level 1: Investing in local companies who trade internationally, priced in ZAR, funds held locally

Large businesses are often not restricted by the borders of the country in which they were started. As they grow, they expand internationally and conduct their operations in other countries.

If you buy shares in Coca Cola, you are not buying just an American company, you are buying a global business that operates in almost every single country (except two) and currency on earth.

A local example for us on the JSE is Naspers. Naspers is a locally listed “South African” company, available for trade on the JSE. However, a huge chunk of Naspers assets and income is derived from its stake in the Chinese business Tencent. Buying Naspers gives you investment into China, in a global business that trades in multiple currencies. In truth, the South African economy has little impact on a business such as Naspers.

It has been said in the past that about 60% of the earnings from the JSE Top40 companies, comes from outside the borders of South Africa, and why often when the rand weakens we see strength in the JSE Top40 since the value of these companies’ foreign earnings increases relative to the Rand.

Level 2: Investing in international companies, investment priced in foreign currency, funds held locally

When buying an ETF in your local brokerage account or TFSA that tracks an international index such as the S&P500, your money is being invested into many internationally listed companies. These international indexes are priced in foreign currencies (dollars in this example), which means your ZAR is converted to dollars when buying the investment. This gives you the benefit of owning assets in these (generally) strong and (more) stable currencies.

The risk associated with this method of offshore investing is that because your funds are held locally (in a South African account) you will eventually have to turn these foreign-based investments into South African Rands if you want cash from them. In a case like Venezuela or Zimbabwe where the local currency is worthless, this will present a serious challenge. But let’s not turn this into an economic piece about the South African economy.

Level 3: Investing in international companies, investment priced in foreign currency, funds held internationally

How do you negate the problem of having to eventually turn your offshore investments into ZAR? You fund an offshore-based investment account. With an offshore account, your funds reside in another country. This means that you can turn these assets into cold hard foreign currency when it comes time to sell. This is true offshore investing as your investments no longer have anything to do with South Africa.

If you intend on living, working or retiring in other countries, it will be wise to look further into your options here.

My financial makeup and conclusion

Most people invested in pension funds and retirement annuities have some layer of offshore investment in level 1, and at a minimum, I feel that everyone should work hard to have a large contribution of level 2 offshore investing in their portfolio, especially if you plan on living and working in South Africa.

If you are planning on working or living in other countries I feel that level 3 is a must. I unfortunately am not an expert in opening offshore bank accounts and finding international brokers, the likes of which Level 3 offshore investing requires.

My current financial makeup is heavily dependent on South Africa, in-fact only a quarter of my assets are priced in a currency other than the Rand, in companies listed internationally. If you boil this down further, the international investments which I have are held locally in South Africa, through South African businesses, and as a result, if I want to sell these investments or gain an income from them this needs to be paid back to me in Rands.

My reliance on the local economy is significant, and as someone who wants to work and potentially live overseas at some point, this poses significant concentration risks to my ability to have an asset base which has enough value in international terms.

This is the inside out view that should form the basis of the decision of where to invest next, and looking at my specific financial position, this is the reason why it is so important for me to increase the contribution of offshore investments in my portfolio. When I am reviewing my financial plan and personal goals for the year, this factor is always high up on my list.

ETF Enthusiast

Use your money to build assets which generate more income than you require to live