Time to Invest Offshore?

Time to Invest Offshore?


The outlook for the global economy is more benign in early 2013 than it has been for some time, and for anyone who has previously been nervous to look outside South Africa for investment opportunities the risks offshore are today lower than they have been for some time – and the risk of investing domestically somewhat higher.

The domestic macro environment

In a post-Budget business breakfast hosted by FNB on 1 March, finance minister Gordhan Pravin pointedly mentioned that sub-Saharan Africa’s growth rate would have been 6.2% last year (actual: 5.7%) were it not for the dampening impact of South Africa’s far lower growth rate.

When one researches individual South African companies, one could be surprised to discover just how much of their revenue today comes from the rest of Africa. Possibly then, we should not view our local corporate growth rate prospects as quite so modest.

While our national GDP may be growing at just 2.3%, many of our Top 40 companies are heavily exposed to a market growing at 6.2%.

A leading investment services house for sub-Saharan Africa reports that while its South African business grew 17% last year (in itself quite robust) the rest of its Africa business grew 66% in a single year. The Nigerian stock market grew 47% last year, and has already posted 20% so far this year, while other markets such as Kenya, Zambia and Zimbabwe are not far behind.

It is expected that within five years many South African businesses will find their revenue from African operations overtaking their domestic operations. Typically, margins in Africa are substantially higher than in South Africa.

That paints a heroic picture of Africa compared to the rest of the global economy, and one that is possibly more immediate than most people have suspected. Five years is not a long time.

For our high net worth clients, this points to a clear investment opportunity in offshore markets. Other emerging markets offer higher fundamental growth than South Africa, while developed economies are currently offering better value from an investment perspective.

The global macro environment

Economists uniformly list three issues confronting the world in 2013: the US economy, the Eurozone crisis and slowing growth in China. Each of the three issues broadly existed a year ago, but for all three the detail has changed.

In the US, the consumer market is improving but the economy is running a deficit that is bigger than Greece’s, percentagewise. The US will have to go through a phase of austerity like that of Greece and other European countries.

Although austerity in Greece, Portugal, Spain and Ireland are familiar themes, the Eurozone crisis too has evolved a long way. These countries have all made dramatic advances in reform programmes, and their people endured serious hardship.

There has also been a softening of stance by the European Central Bank, which has advised it will do everything necessary to stimulate growth in Europe. So the right decisions have been successfully implemented, but it will take time and one cannot point to any economic growth in Europe during 2013.

China was the main driver of global growth during the worst of the recession back in 2008, so its impact on this current bout of recession may be the single most important theme of 2013, given the country has only in March finally completed its leadership transition.

No brave decisions could be made in the lead up to the transition, nor the period immediately after. On top of that there is the question of whether or not China is going through a major structural adjustment. The sense is that future growth levels for China will be 7-8% rather than 11-12%. This will have a significant impact on future global economic growth rates. Brazil and India have also demonstrated rapidly cooling economies.

Where’s the money going in 2013?

Capital flows into South Africa either into fixed direct investment (FDI), equities or bonds. Flows into our equities have been quite modest by global standards, a trend that will continue until investors gain greater confidence in the emerging market story. Instead, developed world capital looking for higher yield to service its liabilities has gone into the bond market where South African returns are high compared to the US and Europe.

These flows will continue and for this reason the rand is more likely to remain stable than to weaken during the remainder of 2013. However, as a result bond markets the world over are expensive.

As to the investment case for South Africa, like other emerging economies that have seen sharply lower growth this year, we remain hostage to the global environment, which has seen planet-wide growth slip for each of the past three years: 2010 (5%); 2011 (3.8%); 2012 (3.1%); and 2013 (projected 3.4%).

South Africa has an additional layer of its own challenges, especially around labour issues. The social compact between labour, business and the ANC has forever changed. Successful demands for higher wages inevitably mean fewer jobs.

For South Africa, these issues of modest global growth, anxiety around structural changes and leadership transition may result in inward investment continuing to ebb and flow for the remainder of this year based on shifting risk appetite.

Where should you invest globally?

One point to watch: pundits frequently suggest offshore markets are better value than the domestic one, arguing foreign companies which have a substantial exposure to emerging markets are the bets to pick. While this is not untrue, does the same argument not apply to South African companies with strong exposure to African markets?

Take MTN, it trades in 21 countries and pays 76% of its earnings in dividend, for an after-tax dividend yield higher than you could get on the money market.

Fortunately, most of our clients would already be comfortably exposed to the Top 40 JSE-listed companies, leaving offshore markets as the stand-out investment theme of the moment. Although some offshore markets had a good 2012, we at FNB Private Clients still reckon that offshore equities are the space to be in over the next five to 10 years.

Notwithstanding markets such as the US currently standing at their all-time highs, you are still getting quality companies at a discount to what they have been at over the past 20 years and will handsomely reward the investor over other asset classes – albeit they are more expensive than last year. Remember, that previous high was reached back in 2007 and many companies have continued to record good increases in earnings in the years since.

There are some particularly good pockets of value to be had at the moment, especially for the contrarian investor. Europe, for all its desperate situation, offers value as it has seen most of its companies sold down and it too offers a discount at the moment.

Other emerging markets are demonstrating exceptional value. Some companies on emerging market bourses are trading at 20-15% discounts over developed markets (which themselves are at a discount to their historical levels).

Over the past three years, these markets were sold down faster than developed ones, plus they have the advantage of stronger fundamentals.

In particular, investors should be on the look-out for those companies paying high dividends as these will be the first to run when the search for yield hits equities.

Mark Appleton
Mark Appleton is a South African Strategist at FNB Private Clients. He has over 30 years investment management experience, having managed the Unilever Pension Fund (R2,5 billion) followed by a 5-year stint as chief investment officer for Marriott Asset Management (R2 billion). Mark has been with FNB Securities as chief investment officer for over 12 years and RMB Private Bank as a South African strategist for three years.