The pros & cons of investing in local ETFs versus offshore ETFs

Astute South African DIY investors understand that building wealth requires looking beyond our borders to invest in global markets.

Exchange-traded funds (ETFs) have become a popular investment option for gaining broad exposure to various stocks and assets across both local and global markets. These passive investments are easy to understand, offering a simple and cost-effective way to access markets for diversification and growth benefits.

However, when including ETFs in your self-directed investment portfolio, it is important to understand the role, relevance and implications of ETFs listed on the Johannesburg Stock Exchange (JSE) that offer direct local or indirect global market exposure in rands, and accessing offshore ETFs directly in foreign currency.

Understanding ETFs

ETFs are designed to track the performance of a specific index, sector, asset class or theme, and they trade on stock exchanges much like individual stocks.

They can hold a collection of assets, such as stocks, bonds, commodities, or other securities, and offer exposure to different markets with options that include the world’s biggest and most developed markets, like the US and Europe, and important emerging markets, such as China and South Africa.  

ETFs are also liquid investments, allowing investors to access their capital at any time, with the option to buy and sell shares throughout the trading day at market prices. Moreover, most ETFs regularly disclose their holdings, which lets investors see the underlying assets in the fund, providing transparency.

Local ETFs

Local ETFs are listed and trade on the JSE. They either track a basket of local stocks or track international indices, allowing investors to gain exposure to offshore assets via a feeder fund that leverages asset swaps.

These “inward-listed” offshore ETFs allow local investors to gain exposure to foreign markets in rands without the local fund manager needing to use their asset swap capacity for direct offshore investment.

Pros of Local ETFs

• Simplicity: Invest using your existing South African brokerage account or trading platform without needing to open offshore accounts, navigate foreign platforms, or apply for SARS clearance.
• Convenience: Everything happens in rands, and you receive statements and tax documents in familiar formats.
• No forex admin: Since you’re buying in rands, there are no additional forex conversion fees beyond what the ETF itself incurs when buying underlying assets.
• Lower minimums: You can start investing with as little as R25 in many local ETFs, making them accessible for smaller investors building their portfolios gradually.
• Regulatory protection: Local ETFs fall under South African financial services regulations, providing familiar legal recourse and investor protections.

Cons of Local ETFs

• Limited selection: While the range of options available continues to grow significantly, investors are still limited to what fund managers choose to list locally. Many niche global markets, sectors, or strategies remain unavailable.
• Currency complications: Returns from investing in global ETFs via local feeder funds can be more variable given the rand’s historical volatility.
• Counterparty risk: Since local ETFs are essentially derivatives of offshore markets, investors are exposed to the fund manager’s operational risk in addition to market risk.
• Market inefficiencies: Local ETFs tracking offshore markets essentially add a layer between investors and the underlying assets, potentially creating tracking errors and inefficiencies.

Offshore ETFs

Investors who want to diversify away from South Africa can take capital offshore as a rand hedge and invest directly offshore in a foreign currency. Offshore ETFs are listed and traded in foreign markets, requiring you to invest through international brokers or platforms.

Pros of Offshore ETFs

• Wider selection: International markets offer thousands of ETFs covering virtually every asset class, geography, sector, and investment strategy.
• Cost benefits: Competition in major markets, like the US, has driven expense ratios down to near zero for popular index funds.
• Direct market exposure: You own shares in funds that directly own the underlying assets, eliminating the additional layer of complexity and potential tracking error introduced by local fund wrappers.

Cons of Offshore ETFs

• Complexity: Investors must navigate foreign exchange regulations, open international accounts, and understand different tax jurisdictions.
• Exchange control compliance: Investors must comply with South African Reserve Bank (SARB) exchange control regulations, including the single discretionary allowance (SDA) of up to R1 million and the annual foreign investment allowance of up to R10 million, which requires tax clearance, as does larger amounts.
• Foreign exchange costs: Converting rands to foreign currencies incurs costs, which vary depending on the platform and the amount invested.
• Higher minimums: Many international brokers require higher minimum deposits (often R100,000 or more) to open accounts, making them less accessible for all DIY investors.
• Regulatory risk: Investors are subject to foreign regulations and have less recourse if something goes wrong.

The Currency Factor

Currency exposure is an important consideration. When you invest in a local ETF that tracks offshore markets, you still get full currency exposure to those markets. The ETF might be priced in rands, but its value moves with both the underlying assets and the rand-to-foreign currency exchange rate.

From a currency perspective, that means local and offshore ETFs tracking the same index should perform similarly over time. The differences lie in costs, selection, and operational complexity rather than currency exposure.

Selecting ETFs

The choice between local and offshore ETFs depends on multiple factors, including your investment knowledge, time availability, portfolio size, investable assets and personal preferences.

Whatever option you choose, ensure you understand the costs, tax implications, and risks involved. Your investment success will depend far more on consistent contributions, appropriate asset allocation, and a sound long-term strategy than on whether your ETFs trade on the JSE or NYSE.