FUNDS ON FRIDAY
by Glacier Research
04 November 2016
Volume 886
The rand – It’s obviously a one-way bet, isn’t it?
Written by: Denzil Burger, Senior Portfolio Manager, MacroSolutions
When you have the memory of being able to buy one US dollar with one rand in 1982 or, more recently,
with less than R7 just five years ago1, it is very easy to simply dismiss the South African currency as a
basket case that can go only one way – down! The current cost of travelling and buying goods and
services overseas reinforces that perception for many locals.
How cheap is the rand really?
The US dollar is the single most important currency globally, as it remains the world’s favoured reserve
currency and many important goods and services are referenced in US dollars – for instance, the oil
price. However, to determine the true value of the rand, we need to consider a number of factors. First, it
is imperative to look at the SA currency against a basket of relevant currencies – ideally our main trading
partners – rather than just against the US dollar. This will tell us if we’re globally competitive and whether
the strength of the US dollar is distorting our view of the rand.
The second important point is that you need to look at currencies in real terms. While over recent years
South Africa has reined in inflation to a rate in the mid-single digits, it still runs higher than the rates of
most of our trading partners. Thus, you would expect the rand to weaken in nominal terms just to
maintain purchasing power parity in real terms. Over and above this, there is a good argument for the
1
www.resbank.co.za
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rand to have to weaken more in order to remain competitive, given, for example, fast-rising local
production costs like wages, electricity tariffs and water charges.
Third, it is critical to look at the currency over the longer term in order to gain the appropriate
perspective. Focusing on recent trends only, can too easily lead to short-term thinking influenced by
sentiment and momentum.
The following graph brings all of these points together as it illustrates how far away the value of the rand
is from the longer-term real trend measured against a basket of currencies of our main trading partners.
This provides a good reference for any discussion on the price of the rand.
Rand deviation from the trend in percentage terms
Sources: SARB, MacroSolutions (June 1996 – June 2016)
Note the extent to which the rand moved to cheap levels in recent times, in line with general perceptions.
We all know the factors that have weighed on the currency in this bout of weakness – local political
developments, including the Nenegate Finance Minister replacement debacle, low commodity prices and
weak economic growth, fears of rating agencies downgrading South Africa, US dollar strength and
emerging markets generally being out of favour, etc.
A wall of bad news flow and overall negative perceptions from investors can see a self-reinforcing move
to extreme levels or at least to a point where the gap between pricing and reality is unsustainably wide
and a reversal becomes inevitable, as per George Soros’ Theory of Reflexivity. That certainly proved the
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case in the bad bout of rand weakness in 2001, and elements of this are being seen again in this current
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episode.
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"I contend that financial markets never reflect the underlying reality accurately; they always distort it
in some way or another and the distortions find expression in market prices. Those distortions can,
occasionally, find ways to affect the fundamentals that market prices are supposed to reflect."
George Soros
Turning currency volatility to our advantage?
When pricing moves beyond what our assessment of the themes in play justify, it provides opportunities
to trade the currency. These would include tactical portfolio management decisions on direct currency
trades (through currency derivatives or buying/selling foreign assets) and other positions where the
behaviour of the rand has a significant impact.
However, you should not lose sight of the strategic value of holding at least a portion of your assets
outside of South Africa. Apart from the usual opportunity arguments, such as the small percentage
South Africa makes up of the total global market capitalisation and the different sectors and companies
available globally, the main benefit of holding offshore assets is through the reduction of the risk profile
of a portfolio.
There are many ways to illustrate the risk reduction of including global assets in a South African
portfolio. One of the clearest is simply to add an increasing amount of a standard global balanced
portfolio to a standard South African balanced portfolio and see how it would change the risk and return
outcome based on historical data. We have done this in the following graph.
Risk profile reduces as global asset holdings increase
(Average returns over 20 years)
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Source: MacroSolutions (data to end of June 2016)
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Note the risk reduction with no meaningful return trade-off as up to 40% global exposure is added into
the portfolio. Changing the mix of assets within the balanced fund, as we would typically do in managing
an integrated portfolio, can increase the benefit further.
Retirement funds in South Africa are allowed up to 25% of the portfolio to be invested globally, with a
further 5% in African investments outside of South Africa. Given that this is fairly modest compared to
the optimal exposure as illustrated in the graph, standard balanced funds would typically regard their
strategic exposure to global as being close to the maximum allowed.
That does not mean to say you should always be at the maximum permitted. As discussed earlier, there
are times when it is appropriate to increase exposure to the rand and this is where the skill of portfolio
management comes into play.
Some investors may have significant assets in excess of their basic retirement savings requirements
and may prefer to hold these in “hard currency assets”; others may have a strongly negative view about
prospects for South African-based investments and also prefer to hold more offshore. The point to
highlight in these cases is that it should be accepted that there could be a cost in doing so.
For the bulk of South African savers with most of their liabilities in South Africa, 20%-30% global
exposure is probably fine. Those looking for a higher offshore weight, but where the exposure is more
actively managed, should consider a worldwide flexible fund.
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Glacier Research would like to thank Denzil Burger for his contribution to this week’s
Funds on Friday.
Denzil Burger - B.Com
Denzil was appointed as portfolio manager for the
investment strategy of the OMLAC(SA) portfolios (Life
funds) in October 2005. He has been actively involved in
asset allocation since the inception of the previous OMAM
Asset Allocation Group in 2002. He continues to play an
active role in the management of MacroSolutions'
institutional international portfolios and is specifically
responsible for the World Balanced Funds.
Denzil joined Old Mutual in 1983, and has held a number
of different positions in the investment area. His broad
experience has given him a wealth of knowledge across a
wide range of investment matters, with one of his
responsibilities having been the coordination of asset
swap activity. He has also managed the optimised
portfolios of the Fairbairn Capital range and the PP Select
Life portfolios since inception until September 2005. He
has also managed pooled and segregated portfolios for
SA and Namibian clients for many years.
.
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