What percentage of your investments should be offshore?

Dear Investor Challenge,

The guy running my country seems a little daft. He once said that showers cure aids, and thinks that the African continent is so large all the others can fit inside it. I’ve seen him on TV trying to pronounce a not so big number, and while my 5 year old seems to be able to do this quite well in pre-school, this guy took four attempts, and I think one of them included an eleventy.

Now I really don’t have too much of an issue with stupid people, in fact Arnold Schwarzenegger remained one of my favourite movie stars, even after he said that he thinks gay marriage should be between a man and a woman.

The bigger issue for me when dealing with the #1 man of missing marbles, is that when he stuffs up, I lose a lot of money. This is something I don’t like very much. It’s better than losing a limb to carnivorous ants of course, but only just.

I’d like to take some of my assets offshore, somewhere safe from such stupidity. How much should I invest offshore? And any tips on where?

Thanks,

Ivan Tout

I have good news for you Mr Tout, I can answer part of that question really quickly. The answer is, 99.26% of your assets should go offshore. I’ll get to where they should go later.

Now I imagine you’ll want to know how I got to that answer, so keep reading, and I’ll try cover it.

On Tuesday night I was at an ABSA Stockbrokers event entitled “Where in the world do I invest”. What a great title, it’s a question so many people have been asking ever since the Rand moved from being a slowly sinking ship, to the ship is on fire and it’s loaded with gunpowder last December.

The presentation was given by someone with serious credentials. Steen Jakobson is the Chief Economist at Saxo bank, and also it’s Chief Investment Officer. Fortunately for those of us in the audience, he also has that dry Scandinavian humour that region is so well known for as I shall demonstrate as I re-tell the only joke he knows:

Einstein dies and goes to heaven only to be informed that his room is not yet ready. “I hope you will not mind waiting in a dormitory. We are very sorry, but it’s the best we can do and you will have to share the room with others” he is told by the doorman.

Einstein says that this is no problem at all and that there is no need to make such a great fuss. So the doorman leads him to the dorm. They enter and Albert is introduced to all of the present inhabitants. “See, Here is your first room mate. He has an IQ of 180!”
“Why that’s wonderful!” Says Albert. “We can discuss mathematics!”

“And here is your second room mate. His IQ is 150!”
“Why that’s just as wonderful!” Says Albert. “We can discuss physics!”

“And here is your third room mate. His IQ is 100!”
“Fantastic! We can discuss the latest plays at the theater!”

Just then another man moves to grab Albert’s hand and shake it. “I’m your last room mate and I’m sorry, but my IQ is only 50.”
Albert smiles back at him and says, “So, where do you think the stock market is headed?”

That was also his version of a disclaimer! A warning, not to blame him when we followed his advice and ended up having to sell body parts to pay our children’s university fees.

So what did Steen come up with using his highly educated foresight? Well there was quite a lot. Firstly, he thinks that the long term future for South Africa is strong. So strong in fact that he puts it in the top 4 countries for the next 15 years. The other three were Australia, Japan and Switzerland.

Then he said that he expects a weaker dollar by year end. His reason why was interesting. Not because all sorts of charts and analysis predicted it, or that policy changes would bring it on, but because the world needs a weaker dollar to prosper, and the world should take the path of least resistance. Apparently he thinks the world is a river.

At the end of the night I hung around to chat with him, and to listen to questions from other people. One of those was a young accountancy student who asked him for one takeaway point. Steen was most inspiring in his answer here. I don’t remember the exact words, but it went something like this: The level of  education is in direct correlation to growth in a country. He was far more inspiring than I can type, and I could see the young student thought so too. I did point out that Zimbabwe is the most educated country in Africa, to which he rightly said that it was an abnormal case.

Then I had two questions for Steen. Firstly I asked “If it’s true that fund managers can’t beat the market…” before I could finish my question he interrupted me saying “It’s undeniably true. I can mathematically prove it!”. Happy to hear that I didn’t waste my time with all|those|articles on why it’s idiotic to try beat the market, I continued: “If that’s the case, wouldn’t it also be the case that economists can’t predict which economy to invest in?”.

There was a little smile, after all, telling people where to put their money was what paid him bucket loads of cash and allowed him to fly business class while visiting 35 countries a year. My question basically implied that he offered no real competitive advantage to his firm, or his clients. His answer was that in most cases, that was is also true.

As a follow up, I asked if we would see the end of the fund manager in the distant future. The answer this time was no, BUT we’re likely to see the end of the large fees being charged by fund managers and that he sees a role for someone to advise people on asset allocation, rather than a stockpicker. And with that, his career was saved!

So was my theory right. Could the following statement be true?

Trying to pick which countries to invest in is as much an exercise in futility as it is trying to pick companies to beat the market. Both of which are far harder than licking your elbow.

When you’re finished trying to lick your elbow, let’s look at the evidence.

Experts would have us believe that we could take the economists word and invest in economies that will show the most growth. The trouble with that, is that economists don’t have a great track record. No I shouldn’t say that, they have an astonishing track record, of complete failure as this Financial Times article said in it’s headline.

The article quotes a study of the number of recessions that happened between the ’90s and 2012. In 2009, there were 49 recessions, guess how many of them were predicted by the world smartest economists? None, zilch, not one. My 93 year old grandmother has a better track record reading tea leaves.

Okay sure 2009 was a special case considering the chaos those idiot bankers put us into. So how about the 60 recessions that occurred around the world in the 90s, how many do you think they managed to predict a year in advance? No it’s not 0 this time, it’s 2. Two out of sixty, those are the kinds of marks you get when all you’ve managed to get right in the exam is your name.

To give them another chance, they checked how many recessions were predicted just 7 months before occurring. This time they did of course do better, but still only managed to predict 20 out of 60. If your doctor had the same track record you’d fire him quickly. Clearly there’s more going on in the economy that the economists can predict.

For the complete evidence, you can take a look at the full study by the IMF here.

All of that correlates with another rather smart theory. It’s called the efficient market hypothesis, and is one of the reasons I believe that fund managers are simply wasting their time, and that index funds are the way to go.

In plain English, the hypothesis simply says that everything we know is already priced into the cost of an asset, making it fairly valued, and therefore it’s impossible to buy anything undervalued, and therefore also impossible to beat the market. This would hold true for currencies, economies or company shares.

Now putting this into the country selection view: Even if you know which countries will have the highest potential future growth and profitability, how do you really know it hasn’t already been priced into their current stock prices, or currency value?

Obviously those with the highest potential future growth and profitability will have a higher price appearing expensive, while those with terrible prospects would appear cheap.

The only way to beat the market, or pick countries to outperform the average, would be to be able to predict the future. Otherwise, and studies have proven this, it’s all down to luck, or taking far higher risks than you intended to.

Rather than trying to chase out-performance and likely end up worse off, all you need to do is buy the average. Money is going to flow to chase performance in any case, and that will render all your predictions about where to invest utterly useless.

And that brings me back to the title of the post. What percentage of your assets should be offshore.

To simply buy the average, ie to invest in the WHOLE world, a market capitalisation weighted index is the way to go. Take a look atthe FTSE All-World Index for example. This index is a breakdown of pretty much all of the world’s markets, developed and developing.

It has the greatest holding, in the largest market, the USA (52.8%), that’s followed by Japan (8.4%), the UK (6.8%), a bunch of European markets, and on and on all the way down to Pakistan, where it holds just 0.01%. South Africa is in there too, at 0.74% split up between 81 companies listed on the JSE.

In terms of companies, Apple has the highest percentage at 1.53%. Facebook is in there too, as is Amazon, Johnson and Johnson, AT&T, Microsoft, General electric and literally many thousands more.

To me, an all world fund is a fund you can literally hold forever. You don’t need to worry about companies crashing, or countries doing a Venezuela on you.

So which are the actual funds you could invest in to diversify throughout the world?

On the JSE you might be tempted to consider the DBXWD ETF, but I’d recommend you don’t, for two reasons. Firstly it charges 0.68% in fees per year, and for an ETF that’s a lot, but more importantly, avoid it because you’re going to pay far more capital gains tax (CGT) than you really should.

This deserves a full article on it’s own (edit, I’ve written it, here it is), but to be brief, capital gains tax isn’t really capital gains tax, it’s mostly inflation taxing with a little capital gains on top. Investing in Rand means you will pay far more capital gains than someone who invests in Dollars or Pounds for example. A huge amount more, there is no upper limit. You could in effect be paying an infinite % of capital gains tax, or even pay CGT on a loss. A better idea would be to invest in a currency that has lower levels of inflation, I chose the Dollar, just to give myself the maximum choice in funds.

So here is my criteria in picking a world fund:

1. It must be low cost.
2. It must be based OUTSIDE of the USA, otherwise if you hold more than $60 000 and you die, the US tax man will collect far too much of your money. This rules out the US based and most recommended VT which costs just 0.14%.
3. It must cover the whole world, not just developed markets but developing too. This rules out IWDA at a cost of 0.2%.
4. It must be fully replicated, ie. own all the shares in the index, and not just a representation.
5. It must own actual shares, and not futures or derivatives.

All this led me to a fund called VWRD, or VWRL if you’d prefer to invest in Pounds rather than Dollars. It tracks the FTSE index I linked to above fully, holds actual shares, is based in Ireland and costs just 0.25%. I’m buying this through my US brokerage account, but any international broker should have access to it. I think of it as a buy and forget holding, something I’ll never need to sell. It’s a fund managed by Vanguard too, the only investment company that acts in the best interests of it customers rather than itself.

Edit in 2019: If you go to my 2018 lessons post and scroll down to point 4) you’ll see that there is a fraction of a percent benefit to actually buying the US based VT after all, but just be careful and make sure you don’t die with too much of it there else the estate tax will take a lot of it!

*Disclaimer, the views above are my opinions. Some people believe you should have 50% of your investments in the country you plan on retiring in, others believe you should try to predict which countries will achieve the best results. Take a look at all the research available and then make up your own mind.