May 30, 2009
By Neesa Moodley-isaacs
It is important to diversify your portfolio. You do this to minimise your risk if some of your investments perform badly. To ensure diversity, you should invest not only across asset classes, but across countries and currencies as well. This week, in the first of two articles on investing offshore, we look at the differences between rand-denominated and foreign currency investments.
If you invest only in South African shares it means that you are investing in only a very small proportion of listed shares around the world. The fortunes of local shares and, in fact, investments in other asset classes in South Africa, are linked to our economic climate.
To avoid the risk posed by investing in a single country and being totally exposed to the economic conditions there, you need to invest offshore.
Diversifying into other countries can also give you protection from the depreciation of the rand against the major currencies. As long as South Africa's inflation rate is higher than that of our main trading partners, such as the United Kingdom and the United States, the value of the rand will decline, on average, to the same degree as the inflation differential.
By investing offshore, you can earn returns on your investment and also benefit from the decline in the rand's value over the long term.
Investing in international share markets also means you have access to industries that are not represented locally and to global brands, such as technology giant Microsoft, car manufacturer Toyota or pharmaceutical company Merck.
There are two main ways you can invest offshore - either through investments made in rands or directly into a foreign investment in another currency.
GETTING EXPOSURE TO OVERSEAS MARKETS WHILE STAYING IN RANDS
There are ways to get exposure to offshore investment markets without having to worry about exchange controls and changing your money into a foreign currency.
South African life assurers and unit trust companies offer rand-denominated offshore investments. They invest your money on your behalf in foreign investments, but your investment remains in rands and your returns on it are reflected in rands. If you withdraw your capital or have your returns paid to you, these will be in rands.
You are not restricted in terms of how much you can invest in these funds.
Rand-denominated offshore investments include life assurance endowment policies, exchange traded funds (ETFs) that track foreign indices, and unit trusts.
Some endowment products and unit trusts have part of their portfolio invested locally and part of it invested abroad.
Endowment policies
An endowment policy usually has a minimum investment term of five years. Although you can access your money during this time, there are usually restrictions on how often you can access it and how much you can withdraw. Any tax due over the term of the policy is paid by the life assurance company at a rate of 30 percent. So the proceeds you receive from an endowment policy have already been taxed.
With an endowment policy, you can appoint beneficiaries to whom the proceeds will be paid if you die. You can also avoid offshore estate costs associated with offshore unit trust funds.
Unit trusts
There are two main types of rand-denominated unit trust that give you offshore exposure - foreign funds and worldwide funds. Foreign funds invest a minimum of 85 percent of their assets outside South Africa at all times. Worldwide funds invest in South African and foreign markets with no restrictions.
Within these two broad categories, you will find different types of funds, including:
Equity funds - these funds invest in shares across different countries and in foreign-based equity funds. At least 75 percent of the fund's market value must be in equities.
Specialist funds - these funds invest in selected shares in specialised sectors across stock exchanges.
Flexible asset allocation funds - these funds can invest in any combination of equities, bonds, money and property markets. There are no limits on how much of the fund can be invested in any asset class.
INVESTING DIRECTLY IN OVERSEAS MARKETS IN A FOREIGN CURRENCY
If you invest directly offshore, you have the benefit of diversifying your investments across countries and across currencies. This means that if South Africa's markets take a dive, and other markets do not, your investment portfolio may be protected to a certain extent from the fall.
However, there are exchange control restrictions on the amount you can invest directly offshore. (See "Exchange controls", above left).
Shares listed on foreign stock exchanges. South African stockbrokers are registered to trade in the local stock market only. You need to use a broker who is registered to trade shares in offshore markets or who has international offices. As is the case with local share investments, you will be charged brokerage fees and advice fees.
Although you can use offshore online brokers, it is probably a better idea to get the help of a local professional to pick shares for you if you are not experienced in managing a share portfolio. Either way you will have to open an offshore stockbroking account.
Remember that share markets can be volatile, but potentially offer higher returns than fixed-interest investments such as bank accounts or property.
Unlisted shares. This type of investment is risky enough in South Africa. It is twice as risky if you are looking at investments in foreign countries - you are likely to have little idea of who you are dealing with and are unlikely to be able to thoroughly investigate the company you want to invest in.
Exchange traded funds. This is like buying a share. There is a multitude of ETFs available on international exchanges and they are as easy to invest in as a local ETF or share. These instruments track the movement of stock market indices and are viewed as passive investments.
Offshore collective investments. By choosing an offshore collective investment (funds like South Africa's unit trust funds), you can invest a relatively small amount and benefit from diversification and the expertise of a professional fund manager.
Offshore funds cover the full range of asset classes, offering exposure to share, bond, and fixed-interest markets (such as money markets). There are also asset allocation funds in which the fund manager decides for you which asset classes to invest in.
Offshore unit trust companies that want to market their funds in South Africa have to apply to the Financial Services Board (FSB) for permission to do so. The FSB considers the jurisdiction in which the fund is domiciled and the regulations under which it operates as well as its investment mandate. It will only register funds that offer investor protection on the same level as local unit trust funds.
The FSB verifies, for example, that a fund is using an independent custodian to look after its assets, thereby offering you protection against any financial difficulty that may befall the fund manager.
In addition, offshore funds registered with the FSB have a local representative, which makes it easier for you to obtain information and service. Many of them are, in fact, offshore funds of local unit trust companies.
As a result, these locally marketed funds are the safest bet for you, and there are currently 390 of them. However, you are also free to invest in any one of more than 100 000 funds around the world.
Bonds. You can invest in other countries' government bonds such as United States treasury bills.
Foreign-currency bank or money market accounts. This would mean holding a bank account or money market account in another country in another currency.
You can also invest in offshore banks' money market accounts or in money market funds (see "Offshore collective investments", above). Keep in mind that your return is likely to be in line with the interest rates in that country. In many cases, these rates are lower than local rates.
Foreign exchange trading. This is a form of speculation where you bet on the movement in the exchange rate between two currencies. You place an order to buy or sell a specific currency "pair" - such as the Euro and the US dollar - based on how you think the exchange rate will move. This type of investment is high-risk.
Property. While you can invest directly in property in another country, bear in mind that it may be difficult keeping an eye on the property market if you are not living there. You will have to keep up with trends such as popular areas, price movements and rentals. Also, being a landlord of such a property may prove more onerous than you anticipate.
If you plan to invest in a buy-to-let property scheme, you may also have to factor in the costs of a letting agent in that country.
Apart from actually buying property, you can invest in listed property shares or real estate investment trusts (Reits). These are property companies listed on the stock market and you would buy them in the same way as you would a share. The benefit of investing in a Reit is that your investment will be managed by a property fund manager and it will be diversified.
EXCHANGE CONTROLS
If you are using money you have earned in South Africa to invest directly in offshore markets in a foreign currency, you are subject to South Africa’s foreign exchange control regulations, just as if you were taking the money out of the country.
In terms of the regulations, you are allowed a one-off limit of R2 million to invest offshore, provided you are over 18 and have a valid tax clearance certificate.
To get this certificate, you must provide the South African Revenue Service (Sars) with a certified copy of your identity document or passport and complete a tax clearance certificate application form. The certificate is valid for only three months, so do all your research beforehand and make sure you know where and how you want to invest before you apply for it.
If your tax is up to date, Sars will inform the South African Reserve Bank, which must then approve the investment. Your tax clearance certificate will include the Reserve Bank authorisation.
If you earn or inherit money offshore, you can leave that money offshore without it being subject to your R2-million offshore allowance. Any investment growth on your foreign investments is also excluded from the R2-million allowance.
Next week: Where to invest offshore and the taxes you'll pay.
  
 
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