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Investing offshore: Fantastic!

Fantastic! A South African’s ability to take money overseas to invest has just doubled. But let’s pause for a minute. Is it really fantastic?

This kind of investment brings with it a plethora of responsibilities and catapults the advisor into a minefield of investment choices, portfolio mixes and numerous decisions involving issues like tax and estate duty. We are now talking about an investment of R4,000,000 per person.

What is the right amount to invest overseas? Where should we invest? What are the implications for investing in this arena? These are just some of the questions which face us before taking this step. As an advisor I already find that an enormous amount of my time is spent researching and understanding market conditions and how the fund managers are strategising to perform according to their mandates. Add to this the fact that I believe that it is important to meet the fund managers. In practice it means that I now have to add international travel to my research time.

How many of us are capable of setting aside this kind of time for investment research on behalf of clients? What may look good on paper when you research a fund, may just leave a knot in the pit of your stomach after meeting the manager. Yet for advisors, it is probably a good idea to “kick the tyres” before you put your client in the vehicle.

A R4,000,000 investment, representing maybe 20% of a portfolio, will catapult the advisor into an environment that has substantially more flexibility and added responsibility. I believe that a holistic insight into your client’s full portfolio is the only way to give the correct advice here.

Several studies have been done showing that a well diversified portfolio should include an offshore allocation. Coronation have recently published research showing that by including a 30% exposure to offshore investments in a portfolio, the overall risk profile is reduced and returns are in fact enhanced. The fact that the allowance has increased should be incidental to the overall investment strategy for your client.

Is Local Offshore, Lekka Enough?

Are the investment returns from South African fund managers that invest overseas as part of their mandate “good enough”, or will our clients be better off with direct investments offshore, thereby possibly exposing them to further layers of costs. For many investors there is also an underlying emotional reason for taking money offshore. Very few people will admit that one of their reasons for investing offshore is that they remember the days when they couldn’t invest offshore and that those days might return.

For those not wanting to get their tax clearance and Reserve Bank approval, there are domestic unit trusts offering Rand based investments offshore. Of 905 FSB approved unit trusts available in South Africa, there are 34 Worldwide funds and 110 Foreign funds. Essentially, domestic funds only invest in local assets. Worldwide funds invest both in local and foreign assets and Foreign Funds invest in only foreign assets.

There are at least two things which should be clear from these numbers :-

  • Choosing the correct offshore unit trust domestically is a challenging task due to the large selection and geographic separation we experience from most managers;
  • Achieving the appropriate blend of these and the domestic unit trusts is the goal – appropriate to each individual’s circumstances when taking into account their financial situation, risk profile and needs.

For many clients the selection of domestic funds investing offshore is more than sufficient for their international portfolio exposure, but what about investors who wish to invest full weight offshore though ? The choice becomes quite overwhelming.

Locally there are about 1,730 domestic funds (the FSB-approved funds and others) in which one can invest, whilst globally there are more than 34,000 funds! (Source: Morningstar Fund Services). These funds can be broken down into some 10 main classifications (Asset Allocation, Convertibles, Derivatives, Equity, Fixed Interest, Money Market, Real Estate, Warrants, Hedge and Fixed Term). There are a number of other ways in which these funds can be classified, filtered or grouped in order to try to make sense of them.

Focussing, by way of example, on just the 4,366 Asset Allocation funds which can be invested in: these funds are available for investments in one of 14 different currencies: Australian Dollar, Bahamian Dollar, Canadian Dollar, Czech Koruna, Euro, Hong Kong Dollar, Japanese Yen, Norwegian Krone, Polish Zloty, Pound Sterling, Singapore Dollar, Swedish Krona, Swiss Franc and US Dollar. (Source: Morningstar Fund Services).

Geographically, these funds invest in assets across the latitudes and longitudes. Some (3,639) invest completely globally, whilst others constrain themselves to certain parts of the globe like the broad Asia-Pacific area (36), Asia-Pacific (ex Japan)(22), the BRIC countries (2 funds), Greater China (2), Euroland (174), Europe (200), European Emerging Markets (4), Europe (ex UK)(4), Germany (6), Global Emerging Markets (39), Global Emerging Markets (ex South Africa)(4), India (2), Italy (11), Japan(5), Latin America (2), Middle East & Africa (10), Netherlands (1), North America (6), Norway(3), Singapore (1), Sweden (11), Switzerland (10), Taiwan (1), UK (73), USA (67) and “Unclassified” (27). (Source: Morningstar Fund Services). The mind boggles!

Should we not rather stick close to home?

South African investors have had mixed fortunes in terms of offshore investing and diversification. In 1998, when South Africans were allowed to start diversifying a portion of their portfolios offshore, local asset managers responded in various different ways.

Some linked up with major foreign players; some merely opened a satellite office servicing the needs of South African clients and others decided to build sustainable businesses offshore.

The problem with the model of linking with a major foreign player is that the South African operation has very little control over or access to the investment capabilities of that investment house. So whereas the brand can be useful from a marketing perspective, the client is not always ideally served from an investment perspective.

The model of setting up a satellite office offshore also has its flaws from an investment perspective, as frequently funds wind up being outsourced anyway, creating additional layers of costs. Eventually clients may decide that it could be more cost-effective for them to approach the foreign firms directly rather than having to pay an extra layer of fees to the SA institution in the middle.

The long-term survivors in this area are the asset managers that have built businesses that are competitive in the markets in which they operate; i.e. if they are based in the UK and Europe they should be able to compete effectively in the UK and European mutual fund and institutional space. Very few South African businesses can claim to have achieved this level of success. Investment houses such as Orbis and Investec can be proud of their successes offshore.

Approximately half of the R500 billion managed by Investec Asset Management is managed offshore, with offices in the US, London, Hong Kong, Taiwan and Australia.

South African multi managers selecting offshore funds have also achieved success within their mandates. Alphen Asset Management is one of a relatively small group of local asset managers with the capabilities and experience necessary to do the quantitative and qualitative research and monitoring of offshore managers and blending these managers into appropriate solutions for domestic clients. Alphen’s International’s multi-managed funds have stood up well to the global correction and are an example of a solution which has demonstrated the necessary risk-adjusted returns domestic clients need from a balanced manager.

How to invest offshore

There is no hand book assisting advisors about offshore investments. Deciding on the right wrapper or trust structure to hold the investment can also be difficult. Balancing costs, due diligence, investment flexibility and tax savings is a decision that needs to be taken with your client. RMB Investment Services and Cidel have excellent administrative platforms (similar to LISPs) that will assist with reporting to clients. A drawback for investment platforms which invest for an individual is that on death, each underlying investment will be exposed to estate legislation in that jurisdiction.

So although these platforms for individuals are cost effective, the administrative tangle of having to wind up an estate in say Guernsey, Luxemburg and the UK is a large consideration and one that very few investors are aware of. This can be solved if the investment is made via a single investment trust, which is an extremely effective estate planning tool (as opposed to tax savings tool).

Unfortunately investing via a trust will bring another layer of costs, which needs to be weighed up as to whether the costs are worth the trade- off in saved estate duty and other ongoing administrative costs.

Investment wrappers that were actively sold in 2001 were the Skandia bonds, Old Mutual Life accounts, MCubed and African Harvest now Sygnia. These products were sold as tax efficient vehicles that could become multi-generational. Servicing these investment wrappers for clients becomes extremely difficult if they are not represented in South Africa.

Skandia now owned by Old Mutual are not represented here and they view any approach from an advisor in Africa as something vaguely dodgy. Old Mutual have never been able to fully explain to me how they use their balance sheet to mitigate taxes that might accrue to clients in their life account product, while at the same time the investment universe that they offer clients seems to be shrinking. Sygnia still have an office here and in my experience have a team of knowledgeable staff who are able to assist with queries.

In the rush to move money overseas in the late 1990’s and early 2000’s when the Rand collapsed, many advisors took advantage of the large fees that were paid by the companies. That left the product overly expensive relative to the tax savings that they purported to offer. Now that the 5 and 8 year redemption penalty period is over, these investment wrappers may just be the right place for your clients to stay and reap the benefits they have already paid for, but consideration should be given to adjusting and monitoring underlying investments.

“Predicting the Rand is impossible over the short term but and it seems a reasonable time to diversify offshore now”, according to Terance Craig of Element, “it’s not as expensive as it was when it was R6 / US$ a few years ago, but it has been particularly strong over the last 12 months so an investment decision to diversify offshore now appears rational rather than emotional” Craig has always been a risk averse investment manager and his comments that the current strong Rand are hurting our exporters added to the other problems that South Africa has like Eskom and political uncertainties lend weight to the need to diversify out of South Africa and take advantage of a gently weakening Rand.

We all know that investing overseas is a lot more complicated that simply getting tax clearance and moving money into another currency. The time to look at one’s offshore investments is undoubtedly now, for a number of reasons. Firstly, local managers will tell you that offshore valuations are looking particularly attractive relative to local stocks and thus present an opportunity to hold some of the world’s real blue-chip global leaders at a good price. Secondly, for those focussed on the shorter- term, local currency managers suggest that the Rand at present levels is relatively strong in relation to its long-term equilibrium position, and the present flows via, for example, the US carry-trade, are probably unsustainable. The increased allowance which is now available to high-net worth investors is a further reason to focus on one’s offshore allocation.

The appropriate blend of assets for each individual investor will depend on their financial position, investment profile and needs. Investors who have not recently re-evaluated their allocation to cheap global assets should speak to a financial advisor who knows and understands the risks to and rewards from investing offshore and make sure that they take advantage of the opportunities which are presenting themselves.

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