We are often asked by our clients how much should they invest overseas? This is on everyone’s lips given the Rand’s recent weakness. There is no right or wrong answer, and a lot will depend on the investor’s specific circumstances.
However have a look at the two graphs below. We have plotted the returns in Dollars for South African equities, US equities and Global equities versus Dollar inflation for rolling 10 year periods. We also show the same returns in Rands versus Rand inflation, in Chart 2.
The result is fascinating, and shows some very long cycles at play:
• The 1990s where characterised by poor returns for SA equities and great returns for global equities;
• The 2000s were the exact opposite, with a decade of great returns for SA equities and poor returns for global equities;
• While the 1990s were a period of Rand weakness and the 2000s a period of Rand strength, what really mattered was what the actual equity markets did, less so the currency.
What lessons can we learn from these graphs, and what do they indicate about the future?
Over time, the performance of equity markets moves around long-run averages (the equity risk premium). Extended periods of superior returns are likely to be followed by extended periods of subpar returns; nothing outperforms forever. The 1990s ended on very high valuations for offshore markets, and attractive valuations for South Africa, which informed much of the following 10 years of returns so it is unsurprising that SA equities did well in the 2000s after a decade of relatively poor performance, and Global equities the opposite.
At the moment, South African equities are on a Cyclically Adjusted PE of 16.1x, global equities on 16x and US equities on 18.2x, approximately at their long-term average. So while our market is slightly more expensive than global equities and cheaper than the US, the valuation differences are not compelling, although we do believe that pockets of our market are very expensive (large cap industrials and cash retailers) and represent investment risk.
What about the likely path forward taking into account similar valuations and long-term return cycles? The superior returns of SA equities and the poorer returns of Global equities over the last decade are unlikely to repeat themselves.
However, that doesn’t mean you must now move all your investment into global equities. Don’t. Not once over any 10-year rolling period did local equity returns fall below the Rand inflation rate, even in the 90s, and if you live in South Africa, your liabilities or living expenses are in Rands. Putting all your assets overseas means you get poorer locally in periods of Rand strength. Ask investors who had most of their investment portfolio overseas in the early 2000s how the following decade felt for them.
But what about the weakening Rand? Don’t base your decision to how much to invest overseas on a view on the currency. The currency tends to defy logic and you will get it wrong. As the graphs show, base your investment decision on the asset you want to buy, and the diversification that it will provide, not the currency or guessing its direction on any one day.
Pulling this together, we suggest that while long-term trends and valuations indicate that global equities are likely to do better than domestic equities, don’t rush for the door, or take a view on the Rand’s current weakness. Rather ensure that your investment portfolios are well diversified. The old adage of “Don’t put all your eggs in one basket” applies now more than ever.
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