Tuesday, 05 August 2014 - 20:00

 

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Seed Weekly - Benefits of Global

The Benefits of Global

It still amazes me that there are many investors out there that refuse to invest globally because it hasn’t generated the same level of returns as local markets over the past 20 years or so. As a result they hold their entire portfolio of assets in a geography (South Africa) that represents around 1% - 2% of globally listed assets.

There is an argument that what has outperformed in the past will typically underperform in the future and vice versa. This is generally as a result of shifting valuations rather than the mere out/under performance and makes investment sense. This argument (which many local asset managers subscribe to) currently proposes that investors should invest more globally because valuations are relatively more attractive than locally.

My argument today is that even if global markets were more expensive than the local markets (and thus expected to generate sub standard returns) that it would often make sense to invest a portion of your portfolio globally.

You’ll probably ask, “How can this be so?”

Simply put – diversification!

Below is a chart of the risk and return of a simply constructed balanced portfolio that only invests into locally listed assets (50% equity, 15% property, 20% bonds, 15% cash) as well as the risk and return of global equity and global bonds (all data displayed in ZAR) for the period 31 December 1992 – 30 June 2014.

I can hear the questions, “Why would you add an investment that produces a lower return with a higher level of risk into your portfolio? Surely there can be NO benefit?”

Because these assets have such a different return profile, their inclusion improves the risk/return payoff profile for investors. By simply allocating 25% to global assets (split equally between Global Equity and Global Bonds) investors would still have generated in excess of 95% of the return of the local only portfolio with downside deviation (a measure of risk) 25% lower than the local only portfolio. The chart below shows how investors would take a marginal reduction in return for a material reduction in risk.

A key reason that the balanced portfolio with 25% global does better on a risk adjusted basis is that it is much better at protecting assets in times of market stress. This is the case as market stress (i.e. falling markets) generally occurs when there is a flight to safety (global bond yields fall, generating capital appreciation in hard currency) and the rand weakens (foreign currency assets translated into rand appreciate).

The chart below shows the different drawdown profiles for the two portfolios. It is evident that the global allocation contributed at exactly the time investors require – in times of market stress in the Emerging Market Crisis of 1998 (max drawdown of 17% vs 28% for local only) and the Global Financial Crisis in 2007/8.

In the investment world there are very few ‘free lunches’ but well thought out diversification is one of the surest ways to make your investment portfolio more robust. Naturally we look to optimise the risk and return payoff within our funds and don’t blindly allocate client investments to any uncorrelated asset class, but this simple illustration shows that even an uninformed investor can improve their portfolio by making the correct strategic asset allocation.

From this analysis it would therefore make sense that where our mandate allows we’d make an allocation to global assets even when their valuations aren’t looking that attractive. Naturally if this were the case (i.e. local assets showing much more value) then the allocation to global assets would be relatively small, but the benefits to a portfolio of even a small allocation to global assets shouldn’t be underestimated.

Seed Funds currently have close to maximum allocation to global assets as a result of the relative valuation being shown outside of South Africa’s borders.

Take care,

Mike Browne

www.seedinvestments.co.za
info@seedinvestments.co.za
021 914 4966

Tue, 05 Aug 2014

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