Investing directly offshore vs indirectly via a feeder fund
Centric Wealth Advisory - SA's Top Boutique Wealth Manager of the year 2022 and 2023
Tailored Independent Advice
Many investors perceive that investing offshore means that their money directly leaves South Africa and is invested in foreign currencies. However, this is not the only way to get exposure to global markets.
There are two ways in which you can decide to invest offshore:
This is physically moving money offshore through exchange controls and investing in direct offshore funds. The South African Reserve Bank (SARB) currently allows a single discretionary allowance (SDA) of up to R1 million per calendar year which does not require SARS clearance and a further foreign capital allowance (FCA) of R10 million subject to tax clearance. This tax clearance is valid for 12 months. Any amount greater than R11 million will require a special approval application.
You’ll need to open an overseas bank account, go through exchange controls, get a tax clearance certificate from SARS, and send your rands overseas into the foreign currency funds of your choice.
What is the purpose of exchange controls? Exchange controls are government-imposed controls and restrictions on private transactions conducted in foreign currency. The government’s major aim of exchange control is to manage or prevent an adverse balance of payments position on national accounts. It involves ordering all or part of foreign exchange received by a country into a common pool controlled by authorities, typically the central bank.
2. Indirectly:
This is the process of investing in local funds that are reported in South African rands (ZAR), however, they are invested in 'feeder funds' that invest in offshore markets. The local currency is 'swapped' (known as an asset swap) into a foreign currency. You enjoy the benefits of offshore market exposure but are not restricted in terms of exchange controls. The process is also easier for an investor as they are investing locally and the money is then externalized via the asset swap, but their fund statements will report in rands.
Example:
Allan Gray (Pty) Ltd was founded in 1973 and Orbis in 1989. We are comparing two global equity funds, which are reported in SA rands and US dollars respectively over the past five years.
Returns between 18/11/2019 and 18/11/2024 are shown in base currencies:
Allan Gray - Orbis Global Equity Feeder Fund (ZA) - 99.16%
Returns reported in SA rands
Orbis - Global Equity Fund (USD) - 65.36%
Returns reported in US dollars
We can see that from the above graphs, the returns when measured in each currency had similar volatility and historic trend lines due to the allocation of offshore equities.
If we plot both funds on the below graph over five years and report the returns in SA rands, we can see how similar the returns are.
(A) Orbis - Global Equity Fund - 103.36%
(B) Allan Gray - Orbis Global Equity Feeder Fund - 99.16%
The 'master fund' would be the Orbis Global Equity Fund and the Orbis Global Equity Feeder fund is "fed" into the master fund.
Why invest directly offshore?
At face value, it would seem that either investing through a feeder fund or directly offshore has very little difference in regard to returns if we measure in the same currency, but we have not factored in the exchange rates and rand depreciation.
Below is a graph where we track the exchange rate for 1 USD since June 1992 and can see that the rand has gradually depreciated over time. If you held 1 USD in June 1992, then the cost of purchasing 1 USD would have increased from R2.66 to R18.08.
Let's look at this practically by way of example.
If we use the returns from the Allan Gray Orbis Equity Feeder Fund and Orbis Global Equity Fund and apply them to an R1 million lump sum invested in both the feeder fund and the direct offshore fund, we can see how exchange rates over the past five years have impacted the initial capital invested.
The rand depreciated 21.58% to the US dollar over the past five years, which resulted in a variance of R18,625 or 0.94% despite similar returns. This may not seem significant over the past five years, but when you look at the rand depreciation over the past few decades, it starts to make sense to have your capital held in a foreign currency. If the rand strengthens, then the variance will be favor of the feeder fund, so a long-term view needs to be taken into consideration.
Fee comparison:
The fees are generally higher for the feeder fund due to the asset swap that needs to occur.
领英推荐
As of 31 October 2024
R1,991,600 x 0.72% (TER) = R14,340
Minimum investment: R50,000 or R1,000 monthly debit order
As of 31 October 2024
$111,844 x 0.6% (TER) =$671.06
$671.06 x R17.97 = R12,059
Minimum investment: $50,000
Capital gains tax (CGT) comparison
For this example, we are using the maximum CGT tax rate for natural persons, and we are assuming the assets are disposed of on 18/11/2024.
In the table above, the Allan Gray Global Equity feeder fund has a gain of R991,600 against the Orbis Global Equity fund’s gain of $44,207.? CGT will be at the effective rate applicable to the investor or investment vehicle, but we’ve used 18% (the maximum for natural persons) in our example.
The CGT payable is R143,021 on the Orbis Global Equity fund ($7,957 CGT x R17.97 exchange rate on the day), versus R178,488 on the feeder fund, which is R35,467 more in tax alone.
This shows that the direct fund is more favorable when it comes to CGT (assuming a weakening currency over time), and cost.
Other considerations:
Direct offshore investments
These types of funds usually have higher investment minimums than rand-denominated funds and tend to prefer lump-sum payments, rather than regular debit orders.
Situs tax: assets that are located in the United Kingdom (UK) or the United States (US) have different taxes applied upon death and are collectively known as 'situs' taxes.
Probate: the process of distributing assets at death, such as immovable property, personal belongings, bank accounts, and investments, either through a valid will or intestate. It is the administration process involved in winding up a deceased estate.
Indirect offshore investments
These types of funds usually have lower investment minimums than direct offshore funds and have lump-sum payments and debit order options available.
The use of a global feeder fund can be a powerful tool for generational wealth creation when investing via a tax-free savings account (TFSA). The interest accrued as well as capital gains tax are exempt from taxation, which means you can get exposure to global markets and not have to worry about tax obligations.
Conclusion:
The objective we want to achieve is to illustrate the benefits of exploring the option of investing offshore, either directly or indirectly, to maximize returns (subject to risk tolerance and investment horizon).
Below is a graph illustrating a local equity fund (Allan Gray Equity Fund) compared to its Global Equity Feeder Fund over the same period 18/11/2019 to 18/11/2024. The Allan Gray Equity Fund has 53.7% exposure to local equities and 41.7% exposure to foreign equities. The Global Equity Feeder Fund has 98.5% exposure to foreign equities (1.5% money market and cash).
By gaining exposure to more global equities, the returns have been more favorable based on historical performance:
(A) Allan Gray - Orbis Global Equity Feeder Fund - 99.16%
(B) Allan Gray Equity Fund - 71.23%
As the reporting currency is in rands, the global equity feeder fund outperforms the equity fund by 27.93% over the past five years.
If R1 million was invested five years ago, the difference in returns would be R279,300 (R1,991,600 - R1,712,300).
If you are considering looking at investing offshore, then get in touch to explore your options. We used Allan Gray in this article but also look at the MSCI World Index as it captures large and mid-cap representation across 23 Developed Markets (DM*) countries. With 1,409 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.
*DM countries include Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the UK and the US.