DOES THE EXCHANGE RATE REALLY MATTER WHEN INVESTING OFFSHORE FOR THE LONGER TERM?

by | Mar 1, 2023

Many SA investors are fixated on the exchange rate when making an offshore investment. Here’s why it matters less than you think, and why you may in fact be doing yourself more harm.

 South African investors spend an extravagant amount of time trying to call the direction of the currency, often at their own expense.  Psychologically, it’s understandable that investors don’t want to externalise their hard-earned ZAR if they feel that the currency will strengthen again in the near term, resulting in an unnecessarily expensive exercise.  In reality, currency predictions are a fool’s game.  The ZAR is one of the most widely traded currencies in the world, making it susceptible to frequent volatile fluctuations.  Whilst short-term movements are impacted by what is happening within our own country, the longer term trend is driven by global macroeconomic factors.  With the SA market comprising less than 1% of global markets, and shrinking, it’s prudent to look at the bigger picture.

Whilst not in a straight line, the ZAR has depreciated against the USD by an average of 6% per annum since the 1970’s.  Over the last 12 months alone, the ZAR has depreciated by a staggering 20%.  So, whilst global markets had a year for the record books in 2022 (and not in a good way!), the weakening currency would have buffered much of that loss for the ZAR investor.

Source:  Profile Data

Investors want it all, and naturally so.  They want to enter the market at a lower entry point, and get the currency call at the cheapest rate.  This very seldom happens; let me tell you why.

The ZAR tends to be a risk-on/risk-off currency (i.e. a cyclical asset). Simply put, in a risk-on environment, investors switch exposure from developed markets (DMs) to emerging markets (EMs), reducing DM asset prices and enhancing EM asset prices and their currencies like the ZAR.  In a risk-off environment, the reverse is true, with investors moving their allocation back to DM assets, resulting in a weakening ZAR, which then acts as a ‘shock absorber’ for an offshore investment.

So, what the ZAR may give you in terms of a potential offshore investment entry point, offshore asset valuations (and asset price momentum) tend to take away, and vice versa.  Furthermore, markets need time for the investment strategies to play out.

To shed further light on this, and highlighting the benefit of focussing on offshore assets rather than currency movements, Clyde Rossouw, respected Portfolio Manager at Ninety One, continues to favour select global equities despite the expected slowdown in global growth, and here is why:

“While 2022 was undoubtedly a tough year for investors, the fall in asset prices resulted in improved prospective return expectations. This is especially true for the high-quality global companies we hold. Despite the fall in their share prices, the fundamentals of these businesses remain strong. They are ideally positioned to navigate the tough macroeconomic environment that lies ahead. Their strong pricing power and low debt levels are a formidable bulwark against inflation and rising interest rates. We remain confident about the runway for growth and the ability of these companies to compound their cash flows. Given these factors, we are increasingly optimistic about the prospective returns from the global equities we hold. Global equity remains our preferred asset class.”   This, despite the ZAR at elevated levels.

There are some very compelling motivations for investing offshore, including access to asset classes, industries and companies not available in South Africa; reduced emerging market and SA-specific risk; diversification benefits and maintenance of ‘hard’ currency spending power.  Investors should be mindful of taking a longer-term view and look past the shorter-term movements of the currency. All too often investors hold back, waiting for the elusive ZAR strength whilst the markets continue to soar, in spite of them.

Despite our significant headwinds – and there are many – South Africans are resilient.  Our country has some of the greatest financial regulatory systems in the world.  Just look at the weather, the space, the beauty, the people, and the freedom of press which, we must remember, is a privilege and not a right.  As the saying goes, “Live where it’s warm, invest where it’s cold”.  Give yourselves the luxury of living the good life in your later years, where the value of your money is not being silently eroded by a structurally weakening ZAR.  Remember the rationale for taking funds abroad, pay attention to what matters, and let the market dance to its own melody.