The great debate: onshore or offshore?

JOHANNESBURG – The all share index just had its best quarter since the third quarter of 2017. But South African investors needed it so badly after seeing their savings dwindle in three of the four quarters last year.

Also bear in mind that the stock market just kept in line with the consumer inflation rate since June 2014 – yes, for nearly five years now.

In contrast, an investment in the MSCI World Index through the rand in June 2014 would have beaten inflation by more than 8percent a year.

Whether we like it or not, the blame for the weak performance of the JSE sits squarely on the inefficient way that the country and its economy was managed and, specifically, the squandering and plundering of precious and scarce resources.

South Africa rode the emerging market wave from the turn of the century when it found favour with the credit rating agencies as the country’s sovereign bonds were upgraded to investment grade.

Before the upgrade the JSE was trading at a discount of nearly 60percent to developed markets in terms of Nobel Laureate Robert Shiller’s Cyclically Adjusted Price Earnings Ratio.

109514383 - The great debate: onshore or offshore?
PRESIDENT Cyril Ramaphosa’s mini-coup in December 2017 managed to steady the ship somewhat, but the Eskom crisis and uncertainties about land expropriation resulted in the increase of the JSE’s rating discount to developed markets to nearly 30 percent in November last year. I Oupa Mokoena African News Agency (ANA)

Steady upgrades of South Africa’s sovereign rating saw the valuation gap between the JSE and developed markets closing and the JSE traded roughly on a par with developed markets from 2007 to end-2015.

Finance minister Nhlanhla Nene’s firing in December 2015 and subsequent irrational decisions and the effective implosion of parastatals saw significant downgrades in South Africa’s sovereign rating resulting in foreign and even local investors heading for the hills.

President Cyril Ramaphosa’s mini-coup in December 2017 managed to steady the ship somewhat, but the Eskom crisis and uncertainties about land expropriation resulted in the increase of the JSE’s rating discount to develop markets to nearly 30percent in November last year – the highest discount since 2005.

After Ramaphosa’s State of the Nation Address (Sona), the Budget, a reprieve by the rating agencies and positive global market sentiment, the discount has narrowed to 20percent.

What it means is that if we as a country can get it right, the discount can be reduced and even eliminated due to a re-rating of our market. All other things being equal, the upside potential of our market is 25percent relative to developed markets.

At this stage, however, it seems that our market will find it difficult to make up lost ground in the short term. Internally, the South African economy is effectively ex growth, given the inability to grow electricity production, the country is in the grip of a confidence crisis, while financial resources are severely constrained.

Externally, Brexit continues to cloud the economic horizon while the global economic slowdown is already under way. The development of the massive offshore oil/gas resource discovered recently, the follow-through of the promised fixed investment and if Ramaphosa is allowed to walk his Sona will mean a new dawn for South Africa.

The opposite is also true. If we do not get it right and Moody’s joins the pack in cutting us to junk, the rating discount of our market could open up to more than 40percent, resulting in the JSE falling by more than 25percent, wiping off more than R1.8trillion of the market value of the JSE.

Optimists may argue that we will get it right and that the deep discount of the JSE warrants a buying opportunity while pessimists will argue that we will not get it right and invest all monies offshore.

Although the future is unpredictable and future asset returns are likely to differ from historical returns, hindsight is always an exact science and from that we can find the combinations of assets that had the optimal returns for their level of risk – also known as the efficient frontier. We calculated the efficient frontier for South African investors by using the total return indices of the major asset classes from 1995 to 2018.

The combination or mix of the assets of the most effective optimal portfolio for high risk tolerance investors was 27percent in global equities, 41percent in South African bonds and 32percent in South African equities.

The combination or mix of the assets of the most effective optimal portfolio for medium risk tolerance investors was 30percent in global equities, 58percent in South African bonds and 12percent in South African equities.

The combination or mix of the assets of the most effective optimal asset mix for low risk tolerance investors was 13percent in global equities, 5percent in global bonds, 36percent in South African bonds, 5percent in South African equities and 41percent in South African cash deposits.

The big question is whether the most effective optimal asset combinations will be the same in the future and will the returns and risks be similar to that of the efficient frontier from 1995 to now.

What history is telling you is that ignoring offshore or onshore equities can be at your peril. Period.

Ryk de Klerk is an independent analyst. Contact rdek@iafrica.com. His views expressed above are his own. You should consult your broker and/or investment adviser for advice.

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