Investing offshore is not only a good idea to access a broader opportunity set and diversify a portfolio across different geographies, sectors, and themes, but it also offers South African DIY investors the potential opportunity to benefit from differences in the rand-US dollar (ZAR/USD) exchange rate.
According to a working paper by the IMF, the ZAR/USD exchange rate is driven far more by global forces than by local data. The biggest contributors to rand volatility are swings in global commodity prices and rising investor fear, often measured by the VIX.
Unexpected U.S. economic data also moves the rand by shifting expectations around the dollar and interest rates. At home, political uncertainty tends to amplify volatility, along with local economic surprises.
Trading in Rands or Dollars
The Clarity by Investec platform provides self-directed investors with an easy way to access global equities and exchange-traded funds (ETFs), with the option to invest in rands (ZAR) or in US dollars (USD).
This distinction is important. When investing in rands, investors buy products listed on the JSE that have offshore exposure, such as rand-denominated feeder ETFs, like the Invest S&P500 Info Tech Feeder ETF (ETF5IT-JSE).
Clarity investors can also make use of their annual individual offshore allowance to transfer ZAR to USD in real time for trading or saving. This foreign currency is then available to purchase shares or ETFs physically listed on foreign exchanges, like the Vanguard S&P 500 ETF (VOO-NASQ).
While these two ETFs track the same index – the S&P 500 – investors can experience different return profiles due to changes in the ZAR/USD exchange rate.
Dual Returns
When you invest directly in USD in US-listed equities, like Apple (AAPL-NASQ) or Alphabet (GOOG-NASQ) or a US-listed ETF, like the S&P 500, your return is made up of two distinct parts.
This dual return includes the asset’s gain (or loss) based on the stock’s or ETF’s performance, and a currency-based return or loss due to fluctuations in the ZAR/USD exchange rate between the day you bought the asset and the day you sell it.
- A weaker ZAR: If the ZAR weakens (depreciates) against the USD, falling from R18/$ to R20/$, for example, every dollar you hold is now worth more when you convert it back into rands. This amplifies your ZAR-based return.
- A stronger ZAR: If the ZAR strengthens (appreciates) against the USD (going from R19/$ to R17/$, for example), every dollar you hold will be worth fewer rands when you liquidate (sell) the equity or ETF. This can reduce or even eliminate your total return.
Trading and Investing Impact
The currency factor should influence how you execute your investment strategy. For buy-and-hold longer-term investors, investing directly can offer a currency hedge because, historically, the ZAR generally trends weaker against the USD over the long run.
If this is your strategy, don’t try to time the currency. Instead, convert ZAR into USD regularly (known as dollar-cost averaging) and focus on buying high-quality stocks or ETFs that you believe will appreciate over a 5- to 10-year period. Should the long-term ZAR depreciation trend continue, you will benefit from the dual boost to your ZAR returns.
Traders can use their account to hold cash in USD before deploying a tactical move to potentially benefit from asset and currency movements. For example, it is tactically advisable to buy more dollars when the ZAR is strong to boost your USD account and wait for the US market to dip before buying a stock or ETF.
The Risk Multiplier Effect
The combination of asset performance and currency movement creates the potential for amplified gains and significant volatility.
The risk multiplier effect relates to the independent movements of the USD asset price and the ZAR/USD exchange rate, which combine to determine your ultimate return in rands.
When the underlying asset price rises, and the rand simultaneously weakens (the ZAR/USD rate goes up), you get a bigger return than an investor who bought the same ETF via a feeder fund. Conversely, when the asset price falls. and the rand strengthens, your losses become compounded.
The other scenario happens when the asset loses value, and the rand weakens. In this case, the weaker ZAR can act as a “buffer” to offset the negative asset return. The inverse is also true: a strengthening rand can cancel out a positive asset return, making all your hard-earned USD stock profit disappear when converted back to ZAR.
The Indirect Effect
The ZAR/USD exchange rate can also impact your investments in a less direct way, potentially influencing your stock or sector picks.
For example, a weaker rand can benefit companies that generate revenue in USD. South African companies that export goods become more competitive as their products are cheaper for foreign buyers, potentially increasing market share and profitability.
During periods of sustained rand weakness, investing in these companies can offer some protection from domestic risk factors, as their earnings tend to rise compared to those of SA Inc. businesses.
In contrast, a stronger rand positively impacts importers as these companies benefit from lower costs that they can pass onto consumers to boost market share and revenue or improve their profitability. This can lead to higher stock prices when reporting better performance.
