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Offshore Investing: Considerations, Risks, and Opportunities

Experts give us their views on the pros and cons of investing client money offshore

 

Article by Eleanor Becker – Originally posted here.

The decision to diversify clients’ funds offshore entails several complex considerations for advisers and wealth managers.

Let’s look at some of the risks, opportunities and considerations involved, according to industry players.

Investment Strategy

The starting point in any investment decision is an investor’s risk tolerance and investment goals, said Attila Kadikoy, managing partner of wealth managers Levantine & Co, in response to Citywire South Africa’s questions.

The investment period relates to the investor’s goals and aspirations and where they are in their financial life. An investor portfolio must be optimised to target a specific return, he added.

Advisers must consider a client’s portfolio holistically and use investments to reach a specified goal, said PSG Wealth CIO Adriaan Pask in a recent media release. They should look at a client’s local liabilities, tax position, estate planning and their investment needs over the short, medium and long term.

Funds that span global markets and asset classes will be well-positioned to meet the needs of most long-term global investors, said Pieter Koekemoer, head of personal investments at Coronation in a November media release.

As there are over 800 [FSCA-approved] offshore investment funds in SA and alternative investments [wrappers] and structured products, according to Ninety One sales manager Siobhan Simpson in an article, an adviser’s investment universe must be fine-tuned.

‘Ensure your shortlisted funds [for clients] contribute to portfolio diversification by examining their return signatures (styles) and correlations to create a well-rounded, risk-conscious, diversified portfolio.’

Assuming more funds equate to a more diversified portfolio is common, but not necessarily accurate, said Simpson. ‘True diversification hinges on adding assets or funds with low or no correlation to existing portfolio components.’

How much to invest offshore is a complex question with many moving parts, said Pask. Some considerations include whether the client intends on retiring abroad or needs income offshore for their children’s education or annual holidays.

Kadikoy said a good starting point is considering how much of a client’s total wealth is tied to their country of residence. ‘Any liquid assets not required to remain [within a certain jurisdiction] can be allocated for investment in an internationally diversified portfolio.’

Regulation 28 was amended in 2022, allowing institutional investors a maximum aggregate exposure to foreign assets of 45%, up from 30%.

However, there is no one-size-fits-all answer in terms of an ideal proportion of discretionary funds to invest.

‘It depends on individual circumstances. Hence the wealth manager should tailor the portfolio to the investor’s needs rather than provide an off-the-shelf solution,’ Kadikoy said.

A common rule of thumb is the ‘age in bonds’ principle, adjusting for risk tolerance, Kadikoy added. According to Morningstar the concept stems from Vanguard founder Jack Bogle, who believed an investor’s bond allocation should roughly equal their age eg: a 45% allocation at age 45. The assumption is one’s risk tolerance decreases with age, and so bond holdings increase.

Lastly, one should go for an offshore fund range that is easy to understand, said Koekemoer.

Restrictions

Be aware of SA Reserve Bank’s (Sarb’s) foreign exchange restrictions. According to its website:

  • Under the SDA, a South African individual (18 years or older) with a valid green, bar-coded SA identity document or smart ID card, may invest up to R1m per calendar year offshore, without needing a tax compliance status (TCS) verification result from Sars.
  • Taxpayers in good standing can invest up to R10m offshore via the foreign capital allowance. They must apply for a TCS verification result from Sars (via eFiling) and present it to the authorised dealer.
  • To invest more than R10m per calendar year an authorised dealer must sapply to Sarb’s Financial Surveillance Department for approval. A Sars TCS verification result is needed.
    Offshore investments can also be funded from the client’s existing foreign currency holdings, said Koekemoer.

Emigration

But how would an offshore investment strategy change, if at all, for clients considering emigrating from South Africa in the future?

In part, this depends on where they emigrate to. ‘If their wealth is within a structure, they must ensure this complies with the country they plan to reside in,’ said Kadikoy.

‘Having an internationally diversified portfolio is beneficial wherever one resides.

‘An adjustment to the portfolio can be made depending on whether the investor’s existing portfolio has exposure to their new country of residence.’

However, he said wealth managers must inform such clients whether or not they can manage a portfolio in the client’s new country of residence.

Timing the Rand?

Investors often hesitate to venture offshore when the rand appears weak, said Simpson. However, ‘adopting a longer-term perspective and overlooking short-term currency movements is advisable when delving into offshore investments’, she said.

Historical data shows the rand has depreciated by an average of 6.4% per annum over rolling five-year periods. Ninety One’s analysis of its investment platform data showed the typical investment horizon for offshore investments is more than 20 years. It found that from 1974 the rand has never appreciated across 20 years.

Further analysis of data since January 2000, for investments in global equities, showed the average return over a rolling one-year period was 11.6% in rand terms: 69% attributed to the underlying assets, 31% to currency depreciation, Simpson said.

“Understanding the rand’s behaviour is essential. It functions as a risk-on/risk-off currency, exhibiting cyclical patterns.”

‘Investors shift their exposure from developed markets (DMs) to emerging markets (EMs) during a risk-on environment. This dynamic can depress DM asset prices while boosting EM asset prices and currencies like the rand. Conversely, in a risk-off environment, the trend reverses as investors reallocate to DM assets, causing the rand to weaken, thus acting as a ‘shock absorber’ for offshore investments.

‘While the rand’s movements can present entry points… offshore asset dynamics may offset gains derived from currency fluctuations,’ said Simpson, advising staying focused on long-term goals and using thoughtful diversification strategies.

‘You can invest your rands in a South African fund that invests all or part of its underlying assets internationally or via an offshore fund,’ Koekemoer added. ‘The latter option diversifies jurisdiction risk and allows settlement in foreign currency, making it easier to fund future international expenses, such as education and travel, or [offshore retirement].

Pre-retirement Considerations

Asked if clients nearing retirement should steer clear of offshore investments, Kadikoy said: ‘Quite the opposite. An individual who is nearing retirement needs to secure and diversify their portfolio. The portfolio’s components will change according to their need to withdraw income from their portfolio.

‘It is not the asset classes that change within the portfolio but the allocation between them. As the individual approaches retirement and is more stable, the manager would choose income-generating assets.’

“He added that multi-asset funds can provide diversification and reduce risk.”

Multi-asset Alternatives

Pask also believes local multi-asset funds currently provide a good alternative to offshore investing.

‘…you’ve got a large spectrum of assets offering reasonable valuations. Allowing a fund manager flexibility, where they can have exposure to a wide range of asset classes, is a good idea at the moment, given the opportunity set,’ he said.

Kadikoy added that multi-asset funds are ‘especially beneficial due to the changing global macro environment led by increasing interest rates’.

Investors must decide whether to build their portfolio using multi-asset funds or opt for a more granular approach with building block funds, said Simpson.

‘The choice hinges on the complexity, monitoring, and control the investor or adviser prefers.

‘Opting for multi-asset funds means the combined insights of selected underlying managers determine the asset allocation,’ she added. ‘The building block approach, which involves investors choosing individual equity, bonds, and cash funds, offers a higher level of complexity and control. However, it requires more frequent decision-making…

‘A middle-ground option involves using a multi-asset approach for 60% to 80% of the portfolio as the core allocation and adding regional, thematic tilts, and sector allocations,’ she said.

The Risk Factor

 

Taxes

Advisers must consider capital gains tax, dividend withholding tax and estate duties. ‘Ensure the solution complies with Sars regulations and request an independent tax opinion if any structuring is involved,’ said Kadikoy.

‘In the fixed income space investments are often taxed at marginal income tax rates, as opposed to capital gain rates,’ said Pask.

Estate Planning

Offshore investments may have significant tax implications for a client’s asset base on their death said Pask. For example, the US and the UK tax individuals who invest there from abroad, with such taxes often amounting to 40% of one’s estate invested there.

“As such, while offshore investment return prospects might be better in nominal terms, the client may be worse off on an after-tax basis, Pask said.”

He suggested seeking advice in this regard.

FNB Fiduciary product manager Remay Olivier said in a media release that clients with assets in a foreign jurisdiction should consider having an offshore will and estate plan.

Fees

Investors must understand how the various service provider’s fee structure works, said Kadikoy. Read the fine print and avoid lockup periods and exit penalties. Account management fees, performance fees, and transaction costs must be considered.

Counterparty Risk and Regulatory Differences

Ensure the local and foreign institution(s) you deal with is well-regulated and transparent, he added. Advisers must ensure they act according to the laws of the jurisdiction they operate in and obtain the authorisation to do business there.

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