Amidst the backdrop of sluggish economic growth, political instability, and policy uncertainty, South Africa's high net worth individuals (HNWI) are increasingly looking to build their asset base offshore.
Offshore investing has always been prudent as an investment diversification strategy, given the relative weakness of the rand against major currencies, and its volatility in relation to other emerging currencies.
However, the incentive to increase offshore allocations now includes other powerful influencing factors, such as funding international education for children, creating a base from which to expand business interests into growth markets, or simply to have a 'plan B’ in place should the need to leave the country ever arise.
There are, of course, various financial instruments available to those who want to externalise their wealth. Many HNWIs are, for example, taking advantage of cross-border banking services to hold cash reserves offshore. However, simply moving your money into an offshore bank account isn't a suitable diversification strategy.
The more popular approach remains share investing, because this asset class is easy to understand and HNW investors are familiar with this investment approach. There also exists a wealth of platforms through which local investors can easily access global exchanges to buy stock in the world's most valuable companies.
But before you max out your offshore allocations on shares, consider first whether your preferred equity funds will actually deliver the returns and diversification you're after. The problem with an offshore investment approach heavily weighted in publicly traded stocks is that fund managers and indexes tend to follow a herd mentality.
Heavily weighting an index, fund or portfolio with blue chip stocks such as Apple, Alphabet, Amazon, Alibaba and Facebook seems like a sensible approach to value investing. However, if investors took the time to drill down into the allocations of ubiquitous equity funds, they'd likely be horrified at the homogeneity of their share holdings across the board.
Certainly, returns from equity funds are fair and comparable with industry averages, and equities offer investors suitable liquidity. However, this approach does little to diversify their offshore portfolio. It is therefore vital that investors understand exactly what their offshore money is exposed to.
More importantly, though, global equities are at all-time highs in developed markets, with market indexes such as the Dow and S&P reaching record highs in September 2018. This trend should bring into question the potential for growth and returns from equity markets in the short to medium term.
Of additional concern is the rising cyclically adjusted price-to-earnings (CAPE) ratio – an inflation adjusted valuation measure usually applied to the S&P 500. Currently sitting at 33, the CAPE ratio has only ever been higher once, which was before the dot-com bubble. This would suggest that a market correction is due in the not-too-distant future.
While we're hesitant to say a crash is coming, it would be prudent for investors who are heavily weighted in global equities to shift their allocations. It is, of course, unwise for an investor to divest completely, but the time is ripe to take some profits off the table and bring exposure down as global equity markets rebase.
For any investor considering expansion into offshore investing, timing is imperative. Those who enter the market too heavily weighted in equities could take a significant knock in value when the market corrects. This would negatively impact 5 or even 10 year annualised returns as the investor would simply be making back their loss, which erodes returns in real terms.
Stonewood is therefore advising clients who want to get the most value from their offshore investments to keep their cash dry by diversify into assets that have, and will continue to deliver robust yields – namely private equity and property.
While these asset classes are illiquid, investors enjoy strong returns that tend to beat the market over time. In our experience, private equity investments through our global partners have yielded an average internal rate of return (IRR) of 15-20% over 5 years. Even the broader private equities sector has delivered average returns of 10%+, albeit with a survivorship bias.
In comparison, if an investor had allocated 100% of their investment to equities in the S&P 500 over the last 20 years (1987-2018), their investment would have grown at a CAGR of 9.92%. In inflation-adjusted terms, that's a return of just 7% per annum.
Offshore property investing also offers equity-beating returns, and is a solid foundation on which to build a portfolio as this has historically been a prolific creator of wealth for investors. Stonewood has managed to secure property investments in the United Kingdom, over 3 and 5 years, that have delivered realised returns on an annualised basis in excess of 15%. In the USA we have recently closed another property transaction that is paying out to investors a 10-12% cash on cash return on their investment.
This makes these instruments ideal adjuncts to equities within a diversified offshore portfolio, especially as they offer returns that compensate investors for a loss of liquidity. In addition, we believe offshore private equity and property investing holds significant up-side benefits, with limited down-side risk, when investors partner with the right provider.
Stonewood, for instance, offers access to large-ticket private equity funds as we hold relationships with top-tier private equity firms in the US and UK, offering exposure to dollar and pound-based investment opportunities.
More importantly, we currently have capacity in these funds to invest, with an established offshore network through which we can source our own deal flows to offer a diverse range of investment opportunities to our clients.
Obviously, client needs are highly individualised, which necessitates that portfolio managers find the best balance between public versus private equity and property to deliver a premium on returns. Applying set ratios across the board will fail to yield the outcome that individual investors are after, which is why we take a personalised advisory approach with each of our HNW clients.
By Eldon Beinart, CEO of Stonewood Capital