By: Reyneke van Wyk, Head of Investment Management at Stonehage Fleming (South Africa)
The global impact of Covid-19 will likely result in a prolonged low growth environment. Supply chains have been severely disrupted and demand has collapsed. Even as activity restarts, unemployment levels will remain high, while central banks keep interest rates low for an extended period.
As markets emerge from the crisis at differing paces, we expect the recovery of countries to depend on a combination of factors including, but not limited to; overall economic position prior to Covid-19, practical and financial response to the virus and importantly, the sectors that make up a large component of their economy. For example, with the low oil price, oil importers are much less vulnerable than exporters. Countries with strong technology and healthcare sectors, which are more resilient with some even benefiting from the crisis, are in a much stronger position relative to those countries very reliant on tourism, which will take much longer to recover.
The South African economy was in a poor position coming into the Covid-19 crisis, already in a recession with large fiscal deficits and rapidly increasing debt levels. Excluding Naspers, there are very few globally competitive companies in the most resilient sectors. Taking all factors into account, South Africa’s recovery could be relatively slow. Arguably, markets were already pricing in the poor economic outlook, however the question now is whether “even cheaper” South African assets are fully pricing the additional economic impact of the virus.
Considerations for offshore investment
Stonehage Fleming has advised families for years to follow a disciplined and consistent approach to invest surplus capital offshore every year, which has typically resulted in foreign allocations of between 50-80% of total assets. Surplus assets are defined as those assets not required to sustain the desired living standards and business interests in South Africa in the medium term. Surplus assets should be defined for each individual or family and a long term strategic offshore target allocation should then be agreed.
In a time of Covid-19, the decision to continue externalising capital at the current weak levels of the Rand depends on two key factors: firstly, the availability of additional long-term surplus capital and secondly, an investor’s current local/offshore allocation relative to the long-term target split. For example, if the investor’s long-term target offshore allocation is 60% of net assets and the current offshore allocation is 40%, they should continue to externalise assets.
It is crucial to follow a phased approach over a targeted time period to reduce exposure to a single currency level and also reduce the risk of emotional investment decisions. If already invested 60% offshore in line with the long-term target, an additional offshore allocation is not required now, unless the investor’s situation has changed and more surplus capital has become available for example.
The firm’s internal and external research indicates that the level of the currency (timing the currency) becomes less important when a phased externalisation approach (such as annually) is followed in the long-term, i.e. the difference in long-term returns is very small for investors who externalise assets each year, whether externalised at the best, worst or average exchange rate every year.
Asset allocation for best risk-adjusted returns
Much wider credit spreads compensate investors for expected defaults. Although these spreads have tightened significantly from the levels seen at the worst point in March, we retain our increased global exposure to quality corporate bonds, with selective high yield and limited Emerging Market debt exposure.
Balance sheet strength has become even more important. The relative attraction of growth themes supported by technology has increased further and we believe that the world will become more focused on health and wellbeing. We are maintaining the tilt in our equity strategies (passive and active) towards quality and growth.
We also believe it is important to maintain a higher level of liquidity to take advantage of any further market dislocations.
The pandemic presents an opportunity for advisers and investors to revisit the investor’s long-term needs and objectives. Discussions should be held around portfolio declines experienced compared to the agreed risk ‘budget’, the investor’s capacity for future declines and general risk appetite, as well as any changes in the investor’s time horizon or income needs as a result of the crisis.
Choosing the appropriate investment adviser is also an important consideration, with an alignment of interests, global experience and depth of resources among the key factors to consider.