South Africans have long had a love affair with offshore investing. This is borne out by the fact that the country is a net external creditor. This means that in aggregate South Africans become wealthier if the rand depreciates.
Despite our natural gravitation to overseas investment markets, the JSE has held its own. In fact, the long-term track record of the JSE is impeccable. It may surprise many to know that from 1900-2016, the JSE produced a higher real return (after taking inflation into account) than any of the 20 largest economies in the developed world. Over the period, the JSE produced an impressive annualised real return of 7.2%. By comparison, US equities produced a real return over the period of 6.4%, the UK 5.5%, Germany 3.3%, Switzerland 4.4% and Japan 4.2%. These are real returns, which take inflation into account and are therefore comparable since it is inflation differentials between countries which determine the fair value of a currency. It is hard to believe but the JSE wins. The figures were published by Credit Suisse. However, times have changed. The go-go years of gigantic profits from the gold mining industry are long gone. The mining industry has played a steadily declining role. For good reason, company profits command a greatly diminished share of GDP, with labour unions driving a fairer bargain after 1994. However, many other frictional costs have dented profit margins. The private sector is drowning in red tape and while service delivery has deteriorated, costs have ballooned.
In an enabling environment, corporate profitability could be maintained despite rising labour costs, via productivity enhancement. However, productivity improvements require investment and businesses are dragging their feet, preferring to invest overseas. The reluctance to invest stems from political and policy uncertainty. President Ramaphosa has gained in authority but not enough to implement the necessary economic structural reforms. Government remains committed to a state-control ideology, despite 26 years accumulated evidence that it does not work and is paralysed by its patronage network and a burgeoning skills deficit. The result is one of the highest unemployment rates in the world and a pitiful economic growth rate. Economists advise that South Africa is right at the back of the Covid economic recovery queue. It will not be until 2024 that we regain our pre-Covid GDP level.
In stark contrast, China has already regained its pre-Covid GDP level. The US is not far behind with a forecast of end 2021. By early 2022, most developed economies and Far East economies will have found their way safely across the valley, a whole two years ahead of our country. While South Africa’s GDP growth rate may rise to 5% this year it is predicted to return to its somnambulist 1.5% rate in the years after, which is pitiful compared to its potential given the huge reserve of natural resources and rapidly growing population. Investors will not find it hard to seek out other countries with a better economic outlook.
Overseas capital markets also provide a wider choice of investible asset classes. Besides the wide choice of different regions, countries and currencies, investors will be able to tap into an array of alternative asset classes, which are particularly appealing whilst most sovereign bonds are offering negative yields. The choice locally is limited to bonds, equities and commercial property. In overseas markets, the choice extends to credit products, absolute return, infrastructure, renewable energy, royalty streams (for instance music royalties) and private equity, which can all be accessed via listed securities. These asset classes provide an alternative to bonds and equities, enabling greater diversification and increased risk adjusted potential. South Africa has incredibly sophisticated financial markets for an emerging market, one of the country’s many winning features. Yet, these asset classes are not sufficiently developed to be listed and available to the public.
It is well established that a significant portion of one’s investments should be invested offshore, due to the heightened risks attached to our beloved country but also due to the multitude of attractive opportunities available around the world. The question is what proportion? A starting point is the Pension Funds Act. Regulation 28 limits overseas exposure to 30%, allowing for an additional 10% exposure to the African continent. In discretionary portfolios, some asset managers may be inclined to regard this figure as a minimum rather than maximum, although the ultimate decision rests with the individual’s personal circumstances.
The next limitation relates to exchange control regulations. Natural persons are allowed an overseas investment allowance of R10 million per annum conditional on providing a Tax Clearance Certificate from SARS. In addition, natural persons can externalise an additional R1 million annual travel allowance for offshore investment purposes. Juristic persons have no allowance for offshore investment but can enter an asset swap arrangement with a financial institution, giving them effective hard currency exposure. Natural persons can also use asset swaps if they want to exceed their exchange control allowance. The drawback is that asset swaps incur an additional annual fee, and the offshore investment needs to be repatriated when the asset swap is reversed at any stage.
Exchange controls are an anachronism, a vestige of the dark days before 1994 when the country was starved of foreign capital inflows in the sanction era. The fact that we still have exchange controls is signal enough that one should maximise offshore exposure.
Want to know more about offshore investments? Overberg Management can help you manage your funds.