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FAIRBAIRN CAPITAL INVESTMENT INTELLIGENCE Intelligence Update April 2010 The benefits of offshore investing The topic of offshore investing has been touched on by many industry professionals and writers, especially recently. The combination of a strong rand and weak global markets has wreaked havoc with the offshore returns of local investors. Despite this, offshore investing introduces diversification benefits into investment portfolios. Currently investors can gain up to 20% offshore exposure when investing in most multi-asset class unit trusts. When deciding how to invest their hard-earned money, it is imperative that investors are familiar with and understand the basic concept of risk and return. Risk is defined as the chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment. As investors need to be compensated for taking on additional risk, the greater the amount of risk that they are willing to take on, the greater the potential return. Some investors can withstand a higher level of market volatility, while others are more comfortable with lower risk levels. An informed investor will not aim to maximize return at any cost, but rather aim to maximize return for a given level of risk which they are comfortable with. Research has shown that adding an offshore component to your investment leads to enhanced risk-adjusted returns over the longer term when compared to a local-only investment. We’ve compared a local fund that comprises only local assets - 60% SA equity, 30% SA bonds and 10% SA cash, the composition of a typical balanced fund – with a combined fund comprised of 48% SA equity, 24% SA bonds, 8% SA cash, 12% offshore equity and 8% offshore bonds (i.e the 20% maximum offshore allocation). The graph below summarises the risk/return ratios of the two funds over rolling 5 year periods, from March 1988 to February 2010. In other words, each point on the graph represents the return per unit of risk of a 5-year investment period. What is clearly visible is that there are periods when a local-only fund delivers better risk- adjusted returns, and there are periods when offshore diversification increases risk-adjusted returns. 5 year rolling stats 3.0 2.5 2.0 1.5 1.0 0.5 - Feb-93 Feb-95 Feb-97 Feb-99 Feb-01 Feb-03 Feb-05 Feb-07 Feb-09 Local Combined Source: I-Net If we stretch the investment period to 10-year rolling returns, as on the graph overleaf, the balanced fund that includes offshore assets clearly outperforms over most of the periods. Indeed it is only the most recent period that a local-only fund has delivered better risk- adjusted returns. Not surprising, given the recent ‘lost decade’ scenario. Please note that while care has been taken to ensure that the information provided in this article is correct, it represents an overview of the topic under discussion and as such does not constitute advice. We suggest that you contact your professional adviser before taking any decisions based on the information herein. Fairbairn Capital is an elite service offering brought to you by Old Mutual Investment Services (Pty) Ltd and Old Mutual Life Assurance Company (South Africa), Licensed Financial Services Providers. 10 year rolling stats 2.5 2.0 1.5 1.0 0.5 Feb-98 Feb-00 Feb-02 Feb-04 Feb-06 Feb-08 Feb-10 Local Combined Source: I-Net Finally, if we look at 20-year periods, the diversification benefits are visible upfront, with the combined fund producing enhanced returns for a given level of risk compared to the local-only fund. Clearly though, those diversification benefits are more pronounced the longer the investor is willing to wait. 20 year rolling stats 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 Local Combined . Source: I-Net An offshore allocation increases diversification benefits because it diversifies the stream of returns. Having exposure to local asset classes only means that investors are solely exposed to local economic conditions, which could be very different from those in other countries. Furthermore, they could miss out on industries, sectors and/or investments that are not available in the local economy, or they are forced to buy assets at stretched valuations. Offshore investing also allows investors to protect against a depreciation of the rand, which has in the past tended to happen quite violently depending on global risk appetite. Over the long term, the higher local inflation (compared to our trading partners) should cause the rand to weaken. Investors should be aware that over the shorter term, offshore asset classes may not perform as expected, partly due to the volatility of exchange rate movements, and partly due to the fact that correlations between markets tend to increase dramatically during periods of increased market stress – the 2008 sub-prime crisis is a perfect example. However, this should not in any way detract from the long-term benefits of having diversification from these asset classes. Please note that while care has been taken to ensure that the information provided in this article is correct, it represents an overview of the topic under discussion and as such does not constitute advice. We suggest that you contact your professional adviser before taking any decisions based on the information herein. Fairbairn Capital is an elite service offering brought to you by Old Mutual Investment Services (Pty) Ltd and Old Mutual Life Assurance Company (South Africa), Licensed Financial Services Providers.
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