Questions on can be very difficult to answer objectively, and more often than not leave the protagonists with even more entrenched views on the merits of their particular argument.
We are all familiar with the conversation…. scarred by the experience of more than a decade of sub-par returns from offshore assets are now convinced that investing offshore was similar to investing in Betamax: Buying a technology that not only lost the war to VHS but has became obsolete.
Can one take an objective view on offshore investing? How should one attempt to gauge its merits? For a South African investor, the rand often seems to be the crucial issue. However, this may be misleading.
One metric that potentially turns the question on its head, is to consider how attractive South Africa appears to foreign investors. All else being equal, they should not have stubborn local biases when it comes to assessing our country’s merits, as these investors compare South Africa to a broad spectrum of opportunities. They’re also less preoccupied with the local currency.
Foreigners were net purchasers of South African equities for much of the past decade, especially in the early 2000s when many South Africans were favouring expensive international assets over cheap local ones. Over the past two years, however, foreign net inflows into our equity market have been largely static. We can surmise that this partly reflects less attractive valuations of our equity market.
In contrast, the last two years have been characterised by significant net flows into our bond market. This might surprise local investors, who typically have limited exposure to South African bonds. However, foreign investors have been willing to take on the duration risk embedded in our local bonds (i.e. the risk of capital loss should interest rates increase) because of the significant yield pick-up that South African bonds have offered over cash when compared to many other international markets.
We’re not suggesting that retail investors should be purchasing South African bonds. In fact, the global search for yield has driven down our bond yields to levels that are hardly sufficient to compensate investors for taking on their duration risk. Rather, investors should take note of the fact that, in terms of equities, foreigners have not been net buyers of our market for the past 18 months. This suggests that despite the market reaching new highs, foreign investors are of the view that there are more attractive opportunities elsewhere.
But what about the rand? It’s very difficult to talk about offshore investing without bringing this up. Not so long ago (01 September 2011), the rand was trading below R7 to the dollar. At the time of writing, it was above R9. Is this still a comfortable level to be buying international assets?
Our Purchasing Power Parity (PPP) models, which give an indication of the relative value of the rand when compared to foreign currencies, no longer suggest that the rand is overvalued. However, we know that the rand can depreciate significantly beyond what one would regard as fair value, just as it stayed stubbornly strong for longer than many expected.
South African investors need to be dispassionate when they evaluate international opportunities. It’s all too easy to extrapolate the past into the future. In these difficult times investors should partner with quality managers regardless of where they are domiciled. After all, regardless of their respective merits, both Apple and Samsung are listed offshore.
