The complexity of wealth can be daunting without the right support, and when there’s an international consideration as well, a number of questions can arise.
Having recently hosted a series of events in South Africa, we found that several of our guests were keen to explore the viability and implications of seeking international diversification with their wealth – some questioned the value, while others were hesitant about reducing their support for domestic solutions.
In this article, we offer some practical insights around traditional investing and real estate, and our behavioural finance expert explains the concept of ‘home bias’.
Sense of duty
First, let’s explore some of the reasons why domestic strategies may feel like a better option on the surface for wealth holders, than international options.
For those fortunate to have accumulated wealth, it is natural to feel cautious about how it is managed. In addition to having personal objectives and goals, many people may also hope that their assets can be of benefit to their community and country.
Since the outbreak of the pandemic, that sense of working to improve society and ‘building back better’ has been adopted by many countries across the world. In South Africa, the government has formally launched its Climate Change Bill, which aims to achieve a low-carbon, climate-resilient economy and society1.
The notion of using wealth to effect local change is understandable, as people are more emotionally connected with their immediate surroundings. Greater familiarity with the domestic economy and business environment can also provide a sense of comfort and greater control.
Finding local solutions to grow wealth may reinforce the emotional sense that the right thing is being done, but is it going to optimise return potential and deliver on long-term investment goals?
The diversification principle
In order to answer that question, let’s next consider why international strategies could merit your attention.
There can be a misconception that placing assets offshore is about tax evasion. For most people, investing internationally is actually about accessing a wider set of opportunities and reducing risk. Crucially, it can be done legally, within a clear set of rules that a regulated investment manager will follow.
The basic principle of diversification involves including different asset types, sectors, themes, countries and more, into your portfolio. These diverse elements can help spread risk more evenly.
As Alex Joshi, Head of Behavioural Finance at Barclays Private Bank explains, a major contributor to diversification is geography: “All economies have an element of idiosyncrasy and different drivers can lead to very different outcomes. Having wider geographical horizons means your risk is spread globally, as is the opportunity to benefit from new opportunities when they emerge.”
From a stock market perspective, it is telling to see how big the limitation can be on overall return potential if you don’t consider diversifying your wealth. The MSCI South Africa index delivered a 0.2% annualised return over the last ten years (in US dollars, up to 30 June 2022), compared to the 8.7% annualised return achieved by the MSCI AC World index over the same period2.
Please note: Past performance is not an indication of future performance. The value of investments, and any income can fall, as well as rise, so you could get back less than you invested. Neither capital nor income is guaranteed.
Ironically, diversifying your portfolio internationally could help you support your home market – by accessing a broader opportunity set, you increase your chances of growing your wealth, which you could then reinvest domestically.
And should you have children who wish to study, live or work overseas, having exposure to the relevant international currency or property market can facilitate that journey. Investing in their development in this way may also benefit the domestic economy, if and when they bring their talent and experience back home.
Incorporating a mix of asset types
It’s worth noting that international diversification is not restricted to traditional investing (i.e. through equities and bonds). Real estate can also provide a useful, long-term source of stable income, as well as the potential for capital returns.
However, real estate is an area that typically falls into the concentration trap. Aside from owning the property you live in, it is common to limit your property portfolio to the area you know best. Buying real estate assets overseas can open the door to a completely different set of growth opportunities while being shielded from domestic market disruptions. That’s not to say it is without risk of course.
Nav Singh, Market head for Africa at Barclays International Bank, observes that the UK has long been an attractive overseas real estate target for South Africans: “Thanks to its robust housing market, relatively stable currency, and political environment, the allure of UK property has been consistently strong.”
He adds, “Similarities between the two nations also provide that much-needed sense of comfort. When it comes to managing your wealth, the head should overcome the heart in influencing decision making.”
Emotional doubts about managing wealth are not new.
The tendency to overweight assets in a particular region is known as ‘home bias’ and is based on a preference for people to lean towards the familiar.
It is not exclusive to finance; people often favour local brands or when faced with two routes home will likely choose the road most travelled. But the long-term financial consequences of home bias for investors can be significant.
Alex Joshi provides more context: “Investors of all levels of sophistication tend to favour the asset types or geographies they know best. But familiarity can falsely create the perception that risk is being reduced when in reality wealth is actually being concentrated in one area. Failure to diversify adequately can significantly increase risk.”
South Africa’s economy has global ties
In the current economic environment, there are many challenges: the pandemic resulted in immense supply chain blockages, prompting inflation to soar when lockdowns eased and global demand returned – a situation exacerbated by Russia’s invasion of Ukraine – and many central banks are subsequently tightening monetary policy.
South Africa is not immune to these difficulties. While growth is forecast to be moderate – underpinned by high exports and rising commodity prices – there are structural challenges amid the need to improve infrastructure, reduce inefficiencies and adapt to meet evolving economic needs. It’s a topic we recently covered in this article.
Against this backdrop, you may want to consider whether such domestic conditions are conducive to your long-term financial goals, or whether they might have a negative impact if all of your wealth is exposed to them.
Not an all or nothing decision
In summary, overcoming home bias may be important to establishing diversification and minimising risk, as well as increasing your potential long-term returns, but that doesn’t mean all assets need to be invested overseas. And any international assets can ultimately be re-shored further down the line, and reinvested in your home market, if you decide that’s what you want to do.
Diversification is about balancing different opportunities and keeping an open mind. Each person has their own requirements for risk and return, and wealth should be managed in a way that provides comfort not unease.
As Alex Joshi concludes, “Having an overweight exposure to your home nation is still better than not being invested at all. However, you should be aware that less diversification may make the investment journey bumpier over the short, medium and long term.”