The Role of International Assets in a Portfolio

With the South African currency’s recent weakness, many investors might have rekindled an interest in offshore investing. If investing locally is considered complicated or overwhelming, then those sentiments are likely to be amplified several fold when investing offshore. The opportunity set and the number of products and service providers dwarf the domestic industry. Mike Soekoe looks at the role of international assets in an investment portfolio.

Investing offshore should not be a knee-jerk reaction to rand depreciation. While the long-term expectation of the relative strength or weakness of the South African rand is a factor in the decision, it should never be the sole determinant.

The various broad local asset classes (equities, property, bonds and cash) may be combined in a portfolio to produce an optimal return for the level of risk taken. This happens because the returns on the various asset classes might move opposite to one another (that is, they may be negatively correlated). International asset classes may offer similar negative or non-correlation. By including these assets in a portfolio, the portfolio can become more efficient. This means, it will generate a similar return with less variability of that return, or a greater return with the same variability as a “local only” portfolio. Hence, international assets offer the opportunity to better diversify a local portfolio.

Foord has always resisted attempts to define risk as volatility or variability. We consider risk to be the chance of a permanent loss of capital and the risk of being wrong in one’s return expectations. These risks are managed by investing in undervalued companies or securities, but also by suitably diversifying a portfolio.

Quantitative research by Darron West of the University of Cape Town shows how much of a fool’s errand international investing can be if not executed for the right reasons and with the appropriate long-term view. Darron analysed data since April 2008 (so that it might be compared directly with the Foord Flexible Fund of Funds, which celebrated its fifth anniversary on 31 March 2013). His study shows that there is no fixed allocation to offshore assets that aids a portfolio in achieving a consistent return of CPI+5% with little risk of capital loss over 12 month periods. In fact, the optimal allocation to offshore investments for this period ranges between 0% and 51%, with some variation from month to month.

It is plainly apparent that building passive portfolios that involve a fixed percentage investment to asset classes including foreign assets to generate absolute real returns is a very difficult task indeed, even with perfect hindsight. If anything, this supports the idea that the motivation for investing offshore must be that the future returns are more certain in amount and frequency.

Since the beginning of 2012, the Foord Flexible Fund of Funds has been systematically increasing its exposure to international assets to the present level of some 60%. The systematic nature of this allocation is in stark contrast to the variability of allocations that arise in the passive quants model derived from Darron’s research. Nevertheless, this strategic decision has been justified by the fund’s recent (and, indeed, aggregate) performance. In fact, the returns of the Foord Flexible Fund over the past 18 months exemplify the role that international assets can and should play in a diversified investment portfolio.

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The Allan Gray-Orbis Global Equity Feeder Fund remains fully invested in global equities. The objective of the Fund is to outperform the FTSE World Index at no greater-than average risk of loss in its sector.