Strong offshore diversification boosts portfolio returns

On the back of the weakness of the rand so far in 2023, offshore investments have offered South African investors excellent diversification benefits, even as local equities have also performed well.  For the period ending 15 May, the currency has lost 12.4% against a broadly weaker US dollar, 16.5% against the UK pound sterling and 14.3% against the euro, as investor sentiment towards South Africa has grown more wary due to developments like intensified load-shedding, lower growth prospects, the country’s grey-listing and fears of US trade sanctions as “punishment” for the government’s seemingly pro-Russia stance.

Consequently, the MSCI All Country World Index has delivered 21.9% in rand terms compared to 8.4% in US dollars, while the FTSE/JSE All Share Index has produced 8.9% in rands so far this year (to 15 May). Despite local economic weakness and higher risk, the local equity market’s performance has been boosted largely by strong returns from globally oriented industrial shares, highlighting the resilience provided by the 75% of the JSE’s earnings sourced from outside South Africa. 

This performance does not mean that global investments are not without their own risks. Much of the equity gains this year are attributable to a handful of global IT giants which were last year’s laggards – other sectors are on shakier ground. Equally, uncertainty remains relatively high over the embedded nature of inflation, the path of interest rates and shorter-term growth prospects. Central banks’ aggressive interest rate hikes have yet to make themselves fully felt across economies and within companies, and data show that countries, sectors and companies are reacting differently to those measures. There could very easily be more negative data surprises ahead.

 All of these factors mean that at M&G Investments we are relatively defensive in our asset allocation positioning and selective in our stock-picking in our global portfolios. We believe that both global bond and equity markets are pricing in overly optimistic scenarios for interest rates and growth, and that national policy rates are more likely to stay higher for longer as core inflation remains sticky, especially in more rigid economies like Europe. Additionally, among other factors, consumers are holding considerable debt, which could weigh more heavily than expected on household spending, company earnings and growth. Because we do not think current yields are adequately compensating investors for these risks, we are positioned neutrally in our asset allocation across global bonds and equities in multi-asset portfolios such as the M&G Global Balanced Fund, for example.

Diversification is especially valuable in the current conditions. Importantly, the widely diverging real yields we are seeing between countries, sectors, companies, issuers and instruments are offering attractive investment opportunities. With in-depth analysis of the specific risks involved, investors can pick up some high-quality holdings at rewarding yields and add excellent diversification benefits. Selective US Treasury bonds, investment-grade corporate bonds and inflation-linked bonds, for example, can all add value to global portfolios for the first time in over a decade.