When it comes to investing, the JSE already offers investors exposure to global markets – but is this enough to truly diversify? Here’s a closer look at how risk-off sentiment and concentration risk can affect your portfolio, and how geographical diversification can help.
Global investing offers South Africans unique and compelling benefits – the most fundamental of which is spreading your overall investment risk. The first main advantage of global investing is geographical diversification. In this article, we explore what this means, and the implications of having only local investments.
The case for geographical exposure
If you have a retirement annuity or local investment, you probably already have offshore exposure built into your portfolio. This is because a number of companies originating in South Africa have expanded their operations beyond our borders, so investing in these companies on the Johannesburg Stock Exchange (JSE) offers your portfolio a degree of exposure to international markets.
In fact, a large percentage of the earnings of the top 40 listed companies on the JSE come from abroad. However, even these stocks can be susceptible to global movements.
Risk-off sentiment affects emerging markets
South Africa, along with countries like India, China and Brazil, is an emerging market, having entered the global economy relatively recently. The political systems of these markets are more established and the financial systems bigger and more liquid than those of frontier markets – such as Nigeria, Oman, Sri Lanka or Vietnam – but less so than developed markets, like the United States or the United Kingdom
Emerging markets present different kinds of risks and opportunities for growth, but when there is a risk-off sentiment against emerging markets, investors are often prone to selling off RSA-based stock.
For example, during the COVID-19 crisis, even large stocks which have mostly offshore revenue streams were disproportionately affected due to market fear and emerging market risk-off sentiment. An element of emerging market momentum carries itself through all the stocks in SA.
The concern with concentration risk
In addition, the earnings of the South African stock market are Africa-centric, and dominated by a few large companies with a limited sectoral footprint. This exposes South African portfolios to localised crises – like civil unrest and drought – and regional shocks, like slumps in commodities (consider how dependent mining stocks are on supply and demand). This creates what is known in the industry as a significant ‘concentration risk’.
If an event seriously affects one of these big companies, or a sector in which a number of these companies operated, such as mining, investors without a balanced offshore exposure would suffer a disproportionate loss. Consider, for example, the sudden ‘collapse’ of a business such as Enron, or, in the South African context, Steinhoff. The resultant massive losses of shareholder value are clear examples of this risk.
This is especially true of the offshore exposure within the JSE. South Africans may believe that what the JSE offers is sufficient, but this offshore exposure is only really offered within a handful of stocks, and is highly concentrated within a few specific sectors. Many of the world’s fastest-growing and most exciting sectors and geographies are almost completely excluded from the JSE.
Global investing offers more diversification across different geographies
Since an investor’s offshore exposure is limited to, and significantly dominated by, a handful of huge companies in very specific sectors, an investor seeking a well-balanced portfolio may not get an adequate degree of diversification by investing only on the JSE. This makes the case for diversification across different geographies and currencies even stronger. Along with access to a wide range of new opportunities, it also heightens the appeal of investing offshore.
This article is not financial advice. Please consult with a financial adviser for financial advice.
- When there is a risk-off sentiment against emerging markets, investors are often prone to selling off RSA-based stock.
- The earnings of the local stock market are Africa-centric and dominated by a few large companies with a limited sectoral and geographical footprint.
- You may not get an adequate degree of diversification by investing only on the JSE.
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