While previously offshore investing was not accessible or affordable to the average South African investor, changes in exchange control legislation have made offshore a realistic option for local investors. There are now very few barriers to entry for those wishing to externalise their funds.
Here we explore some important facts about investing offshore.
- Although the South African stock market is advanced and highly efficient, the stocks available to investors make up less than 1% of investable opportunities. But, despite the relatively small size of the JSE, it is important to bear in mind that JSE-listed companies generate about 65% of their revenue from global markets, meaning that those invested in the JSE have offshore exposure built into their portfolios. As a result of this, investing offshore should not be considered primarily as a rand hedge because your funds already have a solid rand hedge through JSE exposure.
- Diversification is a key determinant when it comes to moving funds offshore, particularly when it comes to investing in international markets that are not available in South Africa, such as alternative energy, pharmaceutical, and artificial intelligence companies. Investing offshore allows you greater diversification across nations, sectors, businesses, asset classes, and currencies.
- Diversifying adequately between developed and emerging markets is an offshore investing fundament primarily because each presents different characteristics and risk profiles. While it’s widely accepted that developed markets are more efficient and liquid, emerging markets – while less efficient – can present greater investment opportunities.
- Although moving money offshore is generally used to hedge against local political unrest and a struggling economy, these issues are not unique to South Africa. The longer-term knock-on effects of Brexit, the migration crisis in Europe, the rise of right-wing conservatism in first world countries, and political unrest fuelled by the climate crisis provide evidence that social and political unrest knows no boundaries and are therefore not good stand-alone reasons to invest offshore. And, as the Covid-19 pandemic has taught us, no economy is immune to a global crisis.
- Building offshore exposure into your portfolio is a means of diversification and risk management, although there is no one-size-fits-all. The level of offshore exposure you require in your portfolio is completely dependent on your personal circumstances, goals and objectives, propensity for risk, and your investment horizon. The starting point when it comes to apportioning offshore allocation in one’s overall portfolio is to adopt a strategic mindset, take a whole view of your financial position, and determine your primary investment objectives.
- In essence, South Africans have two options when it comes to externalising their rands. Firstly, they can invest in a rand-based offshore investment which invests in a local feeder fund which has a mandate to invest in foreign assets. The asset manager, using their foreign exchange capacity, then converts your money into the required currency and invests in offshore assets on your behalf. The second option is to invest directly in foreign-domiciled funds by physically moving your money into an offshore bank account and then directly purchasing offshore investments.
- As a South Africa tax resident, you are permitted to invest up to R11 million per calendar year directly offshore. This comprises a Single Discretionary Allowance (SDA) of R1 million plus a Foreign Investment Allowance (FIA) of R10 million. While permission from Sars is not required to utilise your SDA, you will need to apply for a tax clearance certificate before you can access your R10 million FIA.
- Direct offshore investing can be used effectively if you intend to access the money in the offshore jurisdiction in which you are invested, such as if you plan to retire abroad or send your children to an overseas university. Direct offshore investing should not be used to chase short-term profits achieved as a result of currency fluctuations as this will not translate into long-term gains. Remember, by the time most investors react to market news, the majority of the damage has already been done and exiting the market at an inopportune time can lock in your losses.
- Keeping track of how much of your FIA you transfer offshore in a calendar year is important as you can be penalised for any amounts externalised in excess of your annual allowance. Penalties can range between 20% and 40% of the excess, depending on Sars, although if you’re investing through a reputable local asset manager their services should include monitoring of these limits.
- If you are investing through rand-domiciled funds, you do not need to make use of your SDA or your FIA as you are not physically moving your money offshore. This means that no tax clearance from Sars is required, and there is no limit to how much you can put into your offshore investment.
- Navigating the offshore investment space is difficult to do alone, especially considering the foreign tax and estate planning implications of investing in a foreign jurisdiction. If you plan to invest abroad, it is advisable to partner with a local asset manager with direct and indirect offshore investment capabilities, and who can provide a seamless process for externalising your money. An experienced advisor is able to advise you on constructing a top-down investment strategy that starts with clear goalsetting, adjusting and rebalancing your portfolio as and when necessary, and helping you keep composure when markets react to short-term noise.
- Do not lose sight of the fact that as a local investor, there are significant tax benefits available when it comes to investing, including tax deductions on retirement annuity (RA) contributions, tax incentives, and benefits for tax-free investing. However, the tax benefits of investing through a RA should be tempered against the restrictions imposed by Regulation 28 of the Pension Funds Act which limits the amount of offshore exposure, amongst other things, than can be held in a compulsory retirement fund. Having said that, it is important to note that regulations have recently been amended to increase the offshore exposure allowance in Regulation 28 compliant funds from 30% to 45% which has been well-received by retirement fund investors.
- If you are invested directly offshore, it is unlikely that you will need a foreign will for these assets. However, if you have other assets offshore, such as fixed property or business interests, it may be necessary to seek estate planning advice for that jurisdiction. Keep in mind that many countries, such as the UK and US require that non-residents pay inheritance tax on assets, including shares, which can scupper your intended financial legacy. If you are invested offshore using rand-denominated funds, there is no need to draft a foreign will for these assets and these can be provided for in terms of your South African will.
- Subject to very few exceptions, South Africans enjoy the freedom of testation which allows a person to determine how their assets should be distributed in the event of death. However, many civil law jurisdictions have what is known as mandatory succession rights which can affect how your offshore investments are dealt with after your death. Mandatory succession laws are designed to protect your loved ones – particularly your spouse and children – by ensuring that they inherit a certain portion of the assets held in that jurisdiction.
- A significant advantage of indirect offshore investing is that the minimum investment amounts generally tend to be lower than what is required when investing in foreign-domiciled funds, and it is possible to set up your investment premiums via debit order – an option which is not readily available when investing directly offshore.
With this information in mind, do not lose sight of the fact that one’s offshore investments should form part of your overall investment strategy, and that your reasons for investing offshore should be fully aligned with your overall wealth creation strategy.