Pieter Hugo, Chief Client and Distribution Officer, M&G Investments (M&G Investments)
Foreign assets play an important role in South African investors’ portfolios, both to enhance investment returns and to provide much needed protection.
At M&G Investments, foreign assets have always been core to our portfolios, serving as key contributors to improving our clients’ investment outcomes. We were therefore pleased when the Minister of Finance announced the relaxation of the offshore limits within the pension fund regulations (Regulation 28), by allowing up to 45% of retirement portfolios to be invested offshore. This represents a significant increase from the previous 30% maximum.
Risk and return: How we determine our foreign allocation
It’s important to have an understanding of the role that you want foreign assets to play within your specific portfolio, in terms of their risk and return benefits.
In terms of returns, foreign assets provide local investors with access to regions, sectors and industries underrepresented on the JSE. This allows access to a broader and more diverse opportunity set from which to deliver returns.
In terms of risk, foreign assets are critical in balancing the risks specifically embedded in South African assets, especially within growth assets like equities and, to a lesser extent, property and bonds. They essentially help lower risk by reducing portfolio concentration and the macro and geopolitical risks that emerging economies, like ourselves, are exposed to.
An important role that we play is to determine the optimal mix of foreign and local assets within each of our portfolios by assessing the risk and return characteristics across local and foreign assets, and the interplay between them. For example, global bonds have historically provided good protection to balance out the risk of holding local equities.
The optimal mix of these asset classes enables us to deliver on each of our portfolios’ investment objectives, while also balancing the risks inherent to that portfolio. It’s important to note that depending on the investment objective of the portfolio, the optimal mix of local and foreign assets might differ substantially.
How has our foreign allocation changed in light of the new limits?
We believe that the expected returns available from most local assets are meaningfully higher than those from their corresponding foreign equivalents, on a long-term “through-the-cycle” perspective.
Our aim is to find the appropriate balance between lowering portfolio risk by including foreign assets, while also having an allocation to higher-returning SA assets that allow our portfolios to meet their return objectives.
For our balanced funds, our latest analysis suggests that the optimal neutral asset allocation is about 30% in foreign assets. Given that this does not exceed the previous foreign exposure limits, we do not foresee any immediate changes to the neutral asset allocations for these portfolios.
For more conservative multi-asset portfolios, targeting returns of say CPI+4%, we found that the optimal neutral asset allocation is somewhat less, at about 25% in foreign assets.
New limits provide greater flexibility
While our starting point is to think about a neutral asset allocation, the next important part of our process is to implement our tactical asset allocation views around these neutral weights, as and when the opportunities arise.
Before the change, we wouldn’t have been able to go meaningfully overweight foreign assets if we found valuations attractive and our neutral allocation was set to 30%. Our only option to generate alpha would have been to go underweight (i.e. below 30%).
However, we are now able to go both overweight and underweight foreign assets, which will greatly assist us in generating alpha for our clients. In addition, the increased limit also gives us more freedom to implement currency hedges, which is an important tool in managing a portfolio in South African rands.
We see no immediate change to our current positioning
Given the absolute and relative cheapness of local assets compared to their foreign counterparts, we currently prefer local equity and bonds relative to their foreign equivalents.
Our current positioning in most of our portfolios is well below the previous 30% maximum, and it’s unlikely that we’ll make any immediate changes to our positioning given the expected returns on offer. However, should valuations change, we are now able to respond timeously and take advantage of the greater flexibility to deliver improved investment outcomes for our clients.