What a rollercoaster ride we have been on in 2022. Local and global markets have been incredibly volatile as in February the world came to grips with the Russian invasion of Ukraine and the resultant sanctions. Global inflation continued to spike on increased demand impacted by supply disruptions, caused, in part, by the Ukraine war, together with China’s zero Covid policy. This propelled central banks around the world to aggressively raise interest rates in an effort to stem inflation.
During the year inflation in many countries reached 30-year highs, and central banks will be forced to continue raising interest rates in 2023 to combat inflation. Notably, however, we expect the rate of increase to slow as economic growth slows, but will continue to impact world markets for some time.
As we process this extraordinary global complexity, it is helpful for us take stock and review where we are from an investment perspective and across a range of factors and criteria, starting with asset allocation
This is by far the most important factor to consider when constructing an investment portfolio. Asset allocation refers to how much of one’s portfolio is allocated to local shares, local property, local fixed income (bond and money markets), and to offshore markets. Studies have shown that asset allocation accounts for nearly 90% of total returns over the longer term. When contemplating the ideal asset allocation for a client it is important to keep the big picture in mind, while understanding their respective risk and investment needs. This obviously varies across different jurisdictions. In South Africa, however, the big picture is local versus offshore considerations.
Locally, we are faced with a stagnant economy, a shrinking stock exchange, economic policies that are business unfriendly and an extremely volatile Rand. The advantages of diversifying internationally include access to higher quality companies than locally (think of Nestle, Apple, Microsoft, etc.) and a broader investment universe characterised by companies and sectors of the economy which are simply not comparable in South Africa.
At the macro level, it is important to recognise that the South African economy represents just 0.9% of the global economy and most South Africans are already heavily ‘invested’ in South Africa due to their property ownership. Thus, it is imperative to diversify offshore through your investment portfolio to protect one from being too concentrated in such a small pocket of global economic activity.
Your risk profile and investment objectives will determine what portion of your liquid assets should be invested in offshore companies that provide goods and services globally and are set to continue growing their future earnings. A simple way to look at this is to understand that over the longer term, inflation and interest rates will come down again, and the advanced global economies such as the USA, Eurozone, UK, and China, are likely to be in a better place (and shape) in the future than the South Africa economy. Now let’s look a currency as a factor.
Out house view is to have an allocation to offshore assets in our equity and multi-asset portfolios, being cognisant that currency fluctuations influence these valuations. As humans we tend to think in the short term. Memories are short and sometimes we need to put things into perspective. Bearing this in mind, below is a graph of the rand dollar exchange rate over the past 20 years.
Figure 1. USD ZAR Performance from 31/12/1999 to 30/11/2022
Just 10 years ago one could have bought a US dollar for ~R8.90 and today that same dollar will cost R17.20. This represents an enormous devaluation of the rand over the past decade. This is a long-term trend that has been unfolding over decades and is likely to continue for a myriad of reasons, including political mismanagement of the economy, Eskom, corruption, higher inflation, and interest rates, to name but a few.