An introduction to offshore investing

South African funds invested offshore have increased tenfold over the last 18 years, and this trend is likely to continue as investors become more familiar with investing in foreign markets.

Since 2001 the amount SA investors have invested offshore has increased from R56 billion to R518 billion. While political uncertainty has played a role in the outflow of funds from SA, South Africans have also been broadening their investment horizons and are looking for value elsewhere.

While offshore investments are subject to the risks of price movements implicit in any investment market, investors must also account for any movement in the cross-currency rate over the investment period, as a strengthening of the rand will lead to reduced returns. An investor may also be too far removed from the information flow around his investments to make informed decisions.

Offshore investments can be made through numerous investment vehicles in the various asset classes, such as equities, bonds, property or cash. South African investors have two options when investing offshore. Firstly, one can invest directly offshore. In this case, the investor would have to meet exchange control requirements, convert rands into the offshore currency of choice, and thereafter make the desired investment. Alternatively, an investor could purchase one of the many offshore products available in South Africa. In this instance, the investment is paid for in rands, and any distribution received or withdrawal made would also be paid out in rands. The most common way in which this is done is by investing in a unit trust, which, in turn, uses the offshore allowance of its management company to invest in offshore assets.

The main benefit of offshore investing is the diversification it provides. The performance of global economies is not always synchronised. By investing in offshore markets, one has the ability to access markets that are performing well when one’s domestic market is lagging.

Other benefits include the fact that, in South Africa, as well as in many other emerging markets, inflation is generally higher than in the major developed markets and, as a result, the value of the rand has tended to weaken against developed market currencies over the long term, boosting returns in rand terms. Another advantage for SA investors is that large, developed markets provide a far greater opportunity set.

Investing should be undertaken with a long-term objective in mind. The diversification benefit of offshore investing is ongoing and is aligned with a long-term investment horizon.

One of the other problems that local investors have when looking to take money offshore, is the tendency to invest in low-yielding, low-risk offshore assets. Investors tend to see this as their “safe money” that will protect them from any economic or political risk in SA. However, research has shown that the strong influence of currency fluctuations in offshore investments impacts returns and magnifies the risk. This has resulted in traditionally safe investments exposing investors to unintended risk.

Once investors account for currency fluctuations, they may not be compensated for the risk they had taken on. For example, when the performance of a US cash portfolio is measured in rand, they may be taking on the same risk that they would have been exposed to in a local equity portfolio – an investment in the US fixed income market generated a return of less than 1% over five years to September 2018.

The tax implications of offshore investing can be complex, and expert advice should be sought. Because South African tax law is residence-based, taxpayers are taxed on income according to where they live, rather than on where the income is earned. Hence, the normal rules of taxation apply to offshore investment in terms of capital gains and revenue gains, with the added requirement that the exchange-rate gain or loss must be included, regardless of whether or not the cash is repatriated. Foreign dividends and interest are also taxed, with the added complexity of foreign withholding taxes, which can usually be set off against the tax due.

As with any investment decision, investors wanting to invest offshore are advised to consult their financial advisor to assist them in making optimal investment decisions, given their individual circumstances and objectives.

The information contained on this website (or in this article) is of a general nature and intended for information purposes only. It is neither to be construed as financial advice nor to be regarded as a definitive analysis of any financial, legal or other issue. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner/advisor to take into account your particular investment objectives, financial situation and individual needs.