Investing offshore- Where to start?  

By Francis Marais, Head of Product at Morningstar South Africa 

From a broader set of investment opportunities to currency diversification, offshore investing can be a key strategy to help preserve and grow clients’ wealth over the long term. Offshore investing could feel overwhelming and as an increasing number of investors inquire about investing offshore, the following article aims to provide an overview to assist both advisers and their clients in these conversations.  

The first and most important question is “Why do you want to invest offshore?”. 

This question should be thought of from a long-term strategic asset allocation perspective. Investing offshore should not be done in reaction to negative news headlines and/or short-term market volatility, but rather form part of your holistic financial plan and wealth creation strategy.  

A few reasons to invest offshore can include (but is not limited to): 

• Diversification in different regions globally: South Africa makes up less than 1% of the global economy. Additionally, S.A. is facing a struggling fiscus, high unemployment rates and poor GDP growth. Investing offshore and diversifying one’s investment to include assets outside of South Africa, can offer protection against local market volatility and uncertainty.  

• Broader opportunity set: Global markets offer a wide range of investment opportunities, especially developed markets. Investors can access more countries, asset classes and sectors that are often not available locally. 

• Access to different currencies: Investing offshore offers investors the opportunity to grow their investments in foreign currency and payout in that currency upon withdrawal.  

• Expenses that might need to be paid in a foreign currency in future: Some investors, for example, would like their children to study abroad, or buy a property overseas. For these investors, an offshore investment will make sense and provide a valuable vehicle to cover these expenses when it becomes due.  

1. Currency and exchange rate considerations  

Theoretically, exchange rates are determined by fundamentals, such as economic growth, inflation, and interest rates. Purchasing power parity, or PPP, is one of the most popular theories. It states that countries with higher inflation should see their currencies depreciate over time. But because not all currency participants are profit-seekers, exchange rates can deviate from their theoretical fair values.1  

In the following article “Managing currency risk in turbulent markets” we unpack this topic in more detail. 

Paying attention to currency valuation and the exchange rate is not unreasonable, as you naturally want more bang for your buck, but care should be taken to only focus on this. It may be useful to think about the currency as the hypothetical share price of the country.  

With the above being said, the inherent currency risk when investing outside of South Africa is an important consideration when constructing portfolios with a wider global opportunity set. Currency can add volatility in the short term and some currencies can often trade at levels which differ meaningfully from fundamental fair value.  

The rand has historically traded well outside its estimated PPP fair value with a relatively wide standard deviation of approximately 20%. The rand is shown to rarely trade in line with its fundamental fair value. This would suggest that it is nearly impossible to time the currency, as mean reversions to fundamental fair values occur relatively infrequently and over extended periods of time.2  

Furthermore, asset allocation explains around 90% of the variance in fund performance over time. So, choosing the right mix of assets to invest in and understanding their valuations are very important – alongside your tolerance for risk, and investment horizon. 

2. Direct offshore investing versus using an asset swap/feeder fund  

Let’s start by addressing the difference between investing directly offshore versus an asset swap: 

• A direct offshore investment is an investment in foreign currency made within an investor’s offshore allowance (as set by the South African Revenue Service – SARS). This can be done by investing in an offshore discretionary or endowment/sinking fund investment vehicle (such as a unit trust fund, a fund of funds and/or a model portfolio). 

• An asset swap investment invests in an offshore fund in Rands. In an asset swap investment, you use a third party’s offshore allowance. Your investment is essentially placed into a local fund (also known as a feeder fund) and converted by the management company (Manco) into foreign currency. They then use this foreign currency to buy into a global hard currency fund. This can be used in most products.  

Below we consider the pros and cons of using either strategy: 

Direct Offshore Investment – Benefits  

• Your money is invested offshore in hard currency so you will benefit from a depreciating Rand.  
• Investors typically have two product options – discretionary funds and endowments or sinking funds. Most offshore endowment/sinking funds are domiciled offshore.  
• If domiciled offshore and in an endowment/sinking fund product, when passing away the funds invested will be held and remain offshore and will not form part of an investor’s South African assets. This product has great estate planning benefits if set up correctly.  
• Your proceeds, when you decide to withdraw, will pay out in foreign currency.  
• If the total investment value is R1 million or less no tax clearance is required.  
• These investment vehicles often offer more investment opportunities as the investment universe offshore is much larger than what is available in the S.A. investment market through the local investment platforms.  

Direct Offshore Investment – Disadvantages  

• You get an annual allowance of R10 million plus your single discretionary allowance of R1 million. If you want to invest more than R11 million in a single year, you will have to go through an additional tax clearance process.  
• Higher minimum investment lump sums are required than local investments. Generally, offshore endowment/sinking fund products require an initial investment minimum of $25 000 (these minimums will be platform dependent).  
• No debit order functionality is available on offshore endowments/sinking funds. (Some offshore providers/Linked-Investment Service Providers offer this on discretionary products.)  
• If you use an offshore endowment/sinking fund and you have no nominated beneficiaries when passing away, the product will attract probate which means you would need an offshore will/estate plan to deal with the asset as a South African citizen. This is a lengthy and costly exercise.  
• Offshore life wrappers are only effective while you are a South African tax resident. As soon as you emigrate and become a tax resident of another country the wrappers can be quite costly in terms of tax and in certain instances, you could be taxed quite severely.  

Asset Swap – Benefits  

• The R1 million and R10 million individual offshore allowances are not applicable and any amount (Manco dependent) may be invested.  
• You use the investment platform’s offshore allowance and not yours, so no tax clearance is required.  
• You get the return of the underlying managers and the benefit of the Rand depreciation during the investment.  
• The minimums are much lower with most platforms allowing you to invest with a R50 000 initial lump sum investment or R1 000 per month.  

Asset Swap – Disadvantages  

• The money must always come back to South Africa. It doesn’t necessarily have to form part of your South African estate if accessed via a local endowment. When you access your portfolio, the proceeds will pay out in Rands and not in foreign currency.  
• Your fund choices are limited and depend on fund availability on the local platforms.  
• You pay capital gains tax (CGT) on Rand depreciation.  
• When using asset swap or feeder funds you also add additional layers of fees, as you pay for the local Manco and other fund charges such as trustee and audit fees.  
• The extent of offshore investment for a fund is dictated by regulation. Certain funds have the flexibility to invest all their assets offshore, whereas others are subject to specific limitations.  

We strongly urge investors to consult their financial adviser at the outset of this journey, as your adviser would be best placed to assist with creating a suitable risk profile as well as recommend the different options that are available and best suited to your unique needs.  

The world of investments is complex, with each of the different products on offer, having a different set of rules, fees and tax implications. In the following article “The danger of letting investment vehicles drive your investment journey” we highlight key factors to consider as to why you are investing and what to keep in mind when looking for a suitable product. 

3. The importance of investing with a trusted global Investment Manager   

As mentioned above, the correct asset allocation mix is of great importance when investing offshore. Therefore, the next consideration should be which investment manager to choose to invest with. Investors should seek a trusted investment manager with a proven track record, that provides a well-diversified and well-researched asset allocation underpinned by a solid investment process and, ideally, low fees. 

In closing  

In today’s uncertain global landscape, investors often experience apprehension when assessing their offshore exposure within their investment portfolios. 

Amidst this uncertainty, the four factors within your control include –  

1. Understanding why you want to invest offshore. 

2. Selecting the right investment manager with a fundamental, long-term investment approach. This approach prioritizes the development of resilient, comprehensive portfolios that align seamlessly with investor objectives.  

3. Making informed decisions about the strategy used to gain offshore exposure – whether through direct offshore investments or via an asset swap.  

4. Lastly, when opting for direct offshore investment, careful consideration of which product to use is crucial to attaining your offshore investment goals.