Rafiq Taylor, Head of Implemented Consulting at Sanlam Investments Multi-Manager

There are always compelling reasons for investing offshore, however, many South African investors seem to focus exclusively on trying to time the currency movements.

The burning question on SA investors’ minds is, “Should I invest offshore when the rand strengthens?” While it can be advantageous to invest offshore due to greater purchasing power, investors need to remember that it’s a long game and allow the power of compounding to work in their favour over time, instead of trying to time the market or currency.

Key advantages of investing offshore when the rand has strengthened

Given the recent strengthening of the rand after the formation of the Government of National Unity and other notable events, here are the benefits of externalising your money in a strengthening rand climate:

• Favourable exchange rate means increased purchasing power: A stronger rand means you receive more foreign currency (e.g. US dollars or euros) for the same amount of rands, allowing you to buy more units of an overseas instrument (shares, bonds or unit trust funds). By buying a larger portion of these assets, you maximise your potential returns.

• Cost savings: Exchange and transfer fees, often calculated as a percentage of the money transferred, are less impactful when the rand strengthens because you’re transferring fewer rands to meet your target foreign investment amount. Timing your investment when the rand is strong can help you to enter the foreign market at a more favourable point, leading to potentially higher future gains if the rand weakens.

Don’t forget the rand’s volatility

Countries from around the world use different currencies to make monetary decisions (through central banks) to provide for their own economic needs. When countries import and export goods to stimulate their economies, they mostly trade using the reserve currency (currently the US dollar). The US dollar also has the highest foreign exchange reserves in the world, with 60% of the world’s US$11.5 trillion in foreign reserves denominated in dollars (according to Visual Capitalist, 2024). South Africa also uses the US dollar as a base currency, which determines the strength or weakness of the rand.

Not only is the rand’s volatility influenced by the US dollar globally (amongst other major global factors), but domestic factors such as political uncertainty, commodity price fluctuations, and inflation expectations also play a crucial role. One significant factor contributing to the rand’s strength is the potential for lower interest rates in the US. This was evident when the US Federal Reserve (US Fed) cut rates by 50 basis points at its September 2024 Federal Open Market Committee meeting after years of interest rate hikes. This move had an impact on the rand, encouraging the South African Reserve Bank to cut interest rates around the same period.

To paint a clearer picture of the of the rand’s volatility, we’ve included calendar year movements of the ZAR/USD in a chart, further indicating the vast outcomes played out over the years.

Figure 1: ZAR/USD calendar year moves (1990 – November 2024)

Source: IRESS, Sanlam Investments Multi-Manager, 2024

How is the rand valued according to The Big Mac Index and purchasing power parity (PPP)?

The Big Mac Index is a global standard which was created by The Economist in 1986 – used to measure whether global currencies are at their correct level.

The Big Mac Index has now also been adjusted to consider varying labour costs and barriers to entry – meaning it is now adjusted to take GDP per capita into account. The chart below depicts the price of a McDonald’s Big Mac in rand relative to the US dollar in July 2024 (both are in blue dots). The chart shows that a Big Mac costs 49.9% less in SA (US$2.85) relative to the US (US$5.69) at market exchange rates.

Figure 2: The Big Mac Index

Source: The Economist, 2024

One way to evaluate the theoretical fair value of our currency is to use purchasing power parity (PPP).  At Sanlam Investments Multi-Manager, we use a PPP valuation model, depicted below, which looks at differentials between SA and the US and the commensurate impact on currency valuation. The model illustrates the long-term trend of the USD/ZAR, also showcasing when the rand has been under and overvalued as depicted by the breaches of the ranges of -10% and +10% from theoretical fair value.  As at the end of September 2024, the USD/ZAR fair value was at R16.75.

Figure 3: USD/ZAR PPP valuation model

Source: IRESS, Bloomberg, Sanlam Investments Multi-Manager, 2024

Practical example of the currency impact

Over the longer term, the performance of the rand contributes to an offshore investment’s overall rand return. Rand depreciation adds to the offshore investment’s total return calculated in rands, and rand appreciation detracts from the overall return.

Therefore, when an investor goes into foreign denominated currencies, they will experience market performance returns and currency returns. Looking below on a three-, five-, 10-, and 15-year basis, the investor would have derived the positive annual returns from the depreciation experienced.

Table 1: Currency returns: ZAR/USD

Source: IRESS, Sanlam Investments Multi-Manager, 2024

In addition, the scenarios below display the advantageous purchasing power when purchasing in moments of rand strength. Investor B would acquire $3 638.31 more than Investor A.

Table 2: Scenario analysis (R1 million investment)

Source: Sanlam Investments Multi-Manager, 2024

Takeaway for investors

When investing offshore, investors should take a longer-term view and look past the shorter-term movements in the currency. They should avoid the trap of investing offshore only because of currency movements and rather focus on where to invest, what currencies to include in their portfolio, and what role the offshore investment plays in their overall portfolio.

Other considerations include the diversification benefits from access to asset classes, industries and companies not available in South Africa, and reducing emerging market and SA-specific risks.

ENDS