The volatility of the Rand against the US Dollar has been one of the most noteworthy features of the international currency markets over the past few months with reports from the Goldman Sachs Group stating that the Rand was on course for its strongest start to the year since Bloomberg began collating this information in 1999. However, despite such a strong start to the year for the local currency, it took just under a week recently for the Rand to become one the worst performing currencies out of a basket of 24 emerging market currencies as a result of weak GDP figures and political drama within the SARB.
When we look at the recent market movements within the ZAR/USD pair, it is important for one to note that these currency fluctuations don’t only have an impact on the cost of the forex for your next trip or the transfer of funds internationally, but a weak or strong Rand can also have an effect on your local and offshore investment portfolios. More importantly these currency movements can also have a bearing effect on a number of areas in the economy, which ultimately filters through to the end consumer being you.
INFLATION AND REAL RETURNS
The weakening rand has previously been cited by the reserve bank as one of the key upside risks for inflation. The reserve bank’s primary aim remains keeping inflation within the target range of 3-6% so one would understand their hawkish view on the rising currency. If inflation were to rise beyond this level the reserve bank would certainly be under pressure to raise interest rates, which would in turn directly impact bond prices and the fixed interest portion of your portfolio.
Many unit trust funds benchmark themselves against the ability to achieve a return higher than the inflation rate, also known as a real return. Real returns are calculated by comparing the nominal return less the inflation rate, so rising inflation immediately diminishes the real returns obtained from your investment. Rising inflation therefore puts further pressure on the fund manager to seek yield or return enhancing instruments in order to achieve their return objectives. In an environment with very low interest rates this becomes increasingly difficult so fund managers need to balance the importance between achieving a return target versus adding additional and sometime unnecessary risk to the portfolio.
Another key area in which the currency movements may impact you is through your investment performance and it is important that your portfolio manager be cognisant of when he/she allocates money offshore for a rand denominated fund. This is important because, as offshore investments assist in portfolio diversification, the volatility of the rand can introduce volatility in the fund’s performance in the short term. For most portfolio managers, valuation remains the most important factor but understanding the currency risks when offshore assets are introduced into a fund is important.
WHAT ARE SOME OF THE STRUCTURAL FACTORS THAT AFFECT THE RAND
The risk-on risk-off environment has played a role in the rand’s devaluation to a degree but the depreciation of the rand can mainly be attributed to local government policy, labour unrest as well as a deterioration of the structural factors of the economy. These include budget deficits, trade balance and debt to GDP levels, the land expropriation without compensation issue, local politics, a breakdown in SOE’s and the recent political drama within the SARB. A combination of these factors has led to the manifestation of negative sentiment and when one includes the noise from the US and China on-going Trade Wars etc, this creates a ripple effect for one of the worlds’ most volatile currencies, the ZAR.
SOMETHING TO KEEP IN MIND WHEN INVESTING OFFSHORE
Given the diversification benefits, reduced emerging market and currency risk, and maintenance of ‘hard’ currency spending power, clients are regularly reminded of the wisdom of investing offshore and not adopting an investment strategy that focuses only on South African assets. However, a long-term view is required to fully benefit from an offshore assets’ return potential. While the case for investing offshore is compelling, it is important to consider where the return from an international investment is coming from, the exchange rate and/or the underlying foreign investment.
IN SUMMARY: DIVERSIFY OFFSHORE
It is clear that several domestic and global factors raise uncertainty with the potential to negatively impact an already volatile rand, and therefore your rand-based investments too. The most sensible way to protect your portfolio and the value of your assets from depreciating along with the rand, is to diversify offshore across some more stable, hard currencies. There are a range of local feeder funds and direct offshore fund offerings that can be tailored to meet your needs as an investor, whether you are aiming to invest in South Africa or want access to international markets.
If you would like more information or advice about how to manage your risks by diversifying offshore, contact us today and one of our wealth specialists will get in touch with you!
There’s a famous saying by Harry Markowitz, an American economist and recipient of the John con Neumann Theory Prize “A good portfolio is more than a long list of good stocks and bonds. It is a balanced whole, providing the investor with protections and opportunities with respect to a wide range of contingencies.”