AfrAsia’s latest South Africa Wealth Report found that wealthy South Africans have 83% of their assets invested locally. According to the report, their asset class breakdown between South Africa and the rest of the world is:
Let’s exclude properties, businesses and alternatives, which tend to be illiquid and might correlate with where you live or work. Let’s focus on the 44% made up of local and foreign stocks and fixed income – the liquid, more readily investible assets where investors have greater flexibility. The splits within this category are consistent with traditional asset allocations in terms of both asset allocation and global allocation:
The split between stocks and fixed income might be justifiable. The split between local fixed income and foreign fixed income might also make sense to the extent that local cash is needed to meet short-term liquidity requirements.
Too much invested in local stocks
What doesn’t make any sense is investing twice as much in local stocks as in foreign stocks, when:
- More than half of your wealth is already tied up in illiquid local assets;
- You have enough local cash to meet your short-term liquidity needs;
- The local stock market is <1% of the world.
The purpose of investing in the stock market is to grow wealth and match long-term liabilities like retirement or leaving an inheritance. Surely investors in this position should be aiming to diversify their risk, which is very concentrated in South Africa, and to take advantage of the widest opportunity set possible. This means investing as much of your stock portfolio as possible in the global markets.
This doesn’t necessarily mean excluding the local market (though you probably already have exposure through your retirement annuity/pension). It means that local stocks should have to justify their place in your overall portfolio on more than the fact that they are listed where you live. They should compete on merit with every other stock in the world.
So why do so many South African investors and their advisors still seem to favour local, despite the obvious risks associated with such concentration?
I think it’s time to retire this line. We know that every investor has unique circumstances, and of course everybody doesn’t have the average allocation in the AfrAsia report. But when the averages are so skewed towards local, we can’t keep pretending that this is the perfect end-product of every individual’s unique financial plan. We also can’t keep using this line to avoid debating this important issue.
Isn’t the JSE Internationally Diversified?
“More than half of the JSE’s revenues come from outside of South Africa.” – another line often used to justify local market bias. But those revenues come from a handful of stocks – Naspers alone is more than 20% of the local market, with the top 4 companies making up half the index.
You cannot build a diversified global portfolio with a handful of stocks. There’s simply no benefit to limiting your options like this.
Ask yourself the following question: If these stocks weren’t listed in South Africa, how much of your global portfolio would you invest in them?
Where are your liabilities?
Ideally you want your assets structured in such a way that they match your liabilities. If you’re living in South Africa, it stands to reason that most of your liabilities will be local.
As far as your short-term liabilities are concerned, it makes sense to have sufficient local fixed income exposure to meet these liabilities. The primary goal here is low volatility in Rand terms.
Once you start talking about building wealth and matching your long-term liabilities, you should be less concerned by volatility and you’re probably investing in the stock market.
You might think that adding currency volatility can interfere with your long-term asset-liability matching, or with your dividend flows, but different sources of volatility are often offsetting rather than additive. Stocks are already volatile. Dividends are also volatile in times of crisis. Adding currency volatility doesn’t make them more so, especially since the Rand tends to weaken during times of crisis.
In 2008 the JSE Top 40 index lost 26%. The MSCI World index lost 21% in ZAR. The following year JSE Top 40 dividends fell by 37%, while MSCI World dividends fell by 24% in ZAR terms. Currency volatility in the stock market is a bit of a red herring. If anything, it reduces overall portfolio and dividend stream volatility.
A globally diversified portfolio of your best investment ideas chosen from the widest possible opportunity set is far more likely to meet your long-term goals than a locally concentrated portfolio. The risks are also lower.
Strong Rand keeping you up at night?
Every debate about local vs offshore seems to devolve into a discussion about whether South Africa or offshore will do better. Apparently South Africans worry that South Africa might do well – that Rand strength might somehow make us poorer. They are worried about the possibility that 99% of the world might underperform 1% of the world, despite the fact that they already have 83% invested here. This is insane.
First, this argument ignores the fact that there are many more cheap assets outside of South Africa than inside. Simple Bayesian inference.
Second, it’s not about which will do better, it’s about risk management and where your exposure is. When you are 83% invested in one small country where you happen to live, return expectations become secondary to risk management.
If Turkey, an economy twice the size of South Africa’s, was your best investment idea in the world, would you invest two-thirds of your stock portfolio there, on top of your property and your business?
We need to stop mis-framing this issue as a return issue when it is in fact a risk issue. We can’t keep dangling far-from-certain return potential as a carrot to force-feed local investors something they already have too much of. As advisors and asset managers, is our job to sell SA, or to represent our clients’ best interests?
If you’re anything like the average SA investor, you are already hopelessly overinvested in South Africa. If South Africa recovers and the Rand strengthens, you’ll benefit more than 99% of the rest of the world. Your business, your properties, your local cash will all be worth more in real terms. This is a good thing. You will survive a strong Rand.
Be more concerned about what might happen if, heaven forbid, South Africa and the Rand don’t do so well.