SA balanced funds  – focus on global exposure

By: Rayhaan Joosub, Head of Multi-Asset, Co-CIO, Sentio Capital

Rayhaan Joosub

Balanced funds are crucial to providing savers with real returns to meet their long-term retirement needs. The recent increase in the Regulation 28 limits allows a maximum of 45% of balanced fund assets to be invested offshore, raising the question of how best to invest these assets offshore.

How much should be invested offshore?

We conducted a detailed quantitative study based on historical asset class returns and found the optimal allocation to global assets in a South African balanced fund is approximately 40%. This allocation optimises the probability of outperforming a real return of CPI +6% on a risk-adjusted basis over the long term.

How should the Global Equity allocation be managed?

South Africa has a high bias towards Value and Cyclical investment styles and Emerging Markets (EM) when it comes to domestic equity exposure. These styles tend to outperform only for short periods of time, such as when global growth is accelerating or during a commodity super-cycle. Therefore, for South African investors, the global equity allocation should focus more on Quality and Growth investment styles. A bias towards Developed Markets (DM) is also important, as it maximises the risk-adjusted benefits of the global equity allocation to the balanced fund. This does not mean investing in other styles or EMs like China or India is precluded. However, the expected return bar needs to be higher for these investments, as South African investors already have implicit exposure to these factors due to the country’s commodity-centric EM status.

How should the fixed-income portion be allocated?

Global fixed-income markets offer significant diversification benefits to South African investors, particularly during times of market volatility. This is due to the inverse correlation between the rand and global/local risk asset markets. Diversification benefits are also enhanced in DM bond markets due to the traditional inverse correlation between equity and bond markets, particularly during times of crisis. As a result, when South African risk assets and global equities experience drawdowns, global bond exposure can significantly mitigate this downside risk. However, global bonds have potential drawbacks during periods of significant rand strength. Therefore, hedging the global bond exposure in a balanced fund with appropriately structured currency hedges can improve the risk-adjusted return from global bonds.

What about currency hedging of global equities?

During periods of rand strength, the returns from global equities can be further enhanced by appropriately structured currency hedges. Unlike bonds, where it’s more structural, this would be more of a tactical strategy. In summary, increasing global exposure in balanced funds to 40% can yield significant benefits. However, it is crucial to effectively manage the global equity and bond allocations in a way that complements the domestic portion of the assets. This will maximise the risk-adjusted returns from the global allocation. Sentio has a comprehensive and integrated process covering all asset classes domestically and globally. Our approach

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