JSE rand hedges a poor substitute for a global portfolio

David Nathanson, Global Equity Specialist at Bellwood Capital

With local news agendas being dominated by the rand’s dismal performance, recent GDP woes and an economy slipping into a technical recession – South African investors are increasingly seeking shelter via offshore exposure. But with easy access to foreign markets, investors need to seriously consider the implications of counting on locally listed rand-hedge stocks as a substitute for a truly global portfolio.

This is according to David Nathanson, Global Equity Specialist at Bellwood Capital, who explains that while a number of local stocks are referred to as “rand hedges” – and are said to benefit from a weaker rand – the majority of these are not pure rand hedges and, as such, do not offer the same protection against rand weakness and local political issues as a global portfolio would.

“All too often, South African investors see ‘rand hedge’ and, because they are overexposed to South Africa and are so concerned with managing the associated risk, they overlook the causal drivers of return for these investments. The causal drivers of a stock’s return are business quality and price paid. Investing at the expense of these, for the sake of rand-hedgedness, is likely to lead to inferior long-term returns – all-the-while maintaining significant exposure to South Africa, depending on how pure the rand hedge is.”

Nathanson defines a pure rand-hedge stock as a company with very limited exposure to South Africa by revenues or operations. “There aren’t many pure rand hedges listed on the JSE, though there are a number of less pure rand hedges with varying degrees of protection against rand weakness. The most significant JSE-listed rand hedges are Naspers, Richemont, BAT, AB InBev, BHP Billiton and Glencore.”

With this in mind, Nathanson says investors should only include JSE rand-hedge stocks in their portfolios if they are high-quality businesses trading at attractive prices – the same considerations that would apply to any other investment.

However, given the very limited opportunity set for rand-hedge stocks listed on the JSE, he explains that putting together a diversified portfolio of high-quality businesses trading at attractive prices is near impossible. “In total, there are roughly 100 reasonably liquid stocks listed on the JSE, of which maybe 40 could be considered rand-hedged, at a stretch. If we consider that roughly 30% of all companies are high-quality businesses, this leaves more or less 12 high-quality JSE-listed pseudo rand hedges – of which maybe 5 are attractively priced. Limiting your opportunity set means you forgo at least one of quality, price, or diversification, which has a direct impact on your expected returns and risk profile.”

Another significant drawback of trying to emulate foreign exposure through these stocks, according to Nathanson, is that investors won’t have direct access to their funds from abroad. “South African investment accounts are not directly accessible from anywhere else in the world because of exchange controls, which is a major risk factor. All investors should aim to build wealth that would be accessible from any country, including South Africa, and for this, you need a truly global portfolio.”

Furthermore, the opportunity set is far wider on a global level, with more than 7 000 reasonably liquid stocks, explains Nathanson. “A good process applied to this opportunity set is likely to be vastly superior in terms of quality, price and diversification when compared to a portfolio selected from a smaller subset, such as JSE-listed rand hedges.”

“The larger opportunity set also affords us the luxury to walk away from anything that we’re not entirely comfortable with, at almost no opportunity cost. This can be a big problem for investors limited to smaller opportunity sets, where there is a greater tendency to ignore red flags for lack of alternatives. In today’s volatile economic environment, it makes no sense for a South African investor to limit their options to anything less than global,” Nathanson says.

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