For many investors the timing aspect of converting your hard-earned Rands into foreign currency can be quite the conundrum.
Do you succumb to the knee-jerk reaction ingrained in all of us when the Rand weakens significantly and convert your Rands regardless? Or do you wait with bated breath, and some healthy scepticism, for the Rand to strengthen?
But this just leads to a spiral of more questions like, how much further can it weaken? When will it strengthen? What will it go back to? How long will it take? Will it ever go back to those levels? What is a good value for the Rand? And so it goes on.
These questions have been asked of us by many of our clients hence, we have spent some time thinking of a sensible solution. As with all things wealth management, at Classic Wealth we prefer to have a measured approach to buying dollars. Emotion is a very powerful destroyer of value and can hurt your investment outcomes if you cannot remain objective.
Firstly, we believe that having an internationally diversified portfolio is of immense value to a client when it comes to preserving wealth, which is why we urge each client to buy dollars at some point. Diversification cannot be achieved by investing solely in South Africa as 99% of the world’s tradeable instruments are listed outside of the borders of South Africa. The coronavirus does exacerbate extreme outcomes in a portfolio, either positive or negative, but if it tends towards the negative, you really want to ensure you have more funds invested offshore than directly in South Africa.
Secondly, we think the Rand has been oversold and is too weak based on the current situation that prevails worldwide.
So how do we achieve a desirable outcome for our clients when purchasing foreign currency? We separate your currency exposure decision from your initial currency conversion action by making use of currency hedges. This prevents you from locking in a weak exchange rate at present and allows you the opportunity to choose the final exchange rate while still being able to implement your offshore portfolio immediately. All you need to implement this successfully, is some patience.
The below graph depicts the Rand Dollar exchange rate stripped of inflation showing us the real trend of the Rand.
Removing inflation allows us to compare the true purchasing power of the Rand versus the US Dollar. What becomes very clear, is that there is a strong Rand depreciation trendline against the Dollar over time, with big swings around this trendline. The trendline is depicted in red in the below graph.
Our hedging rules are based around this long-term trendline. We employ the use of standard deviation analysis to determine what portion of your portfolio should be hedged against a weakening or strengthening Rand. It also helps us to determine when a portion of the hedge should be unwound.
If you follow the rules-based system we use for our clients, you should end up on the green line as indicated on the above graph. This green line is the average currency level at which the final lock-ins were achieved. This may take some time to play out, but all in all, this is not a bad position to be in.
Having a rules-based approach to buying foreign currency lends itself to making prudent decisions and not overpaying relative to the long-term value of the Rand.
Contact us if you would like to know more.