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https://www.youtube.com/watch?v=dU-0PD33uEQ

1. Diversification mitigates portfolio risk

The primary advantage of offshore investing lies in the diversification it offers across countries, industries, companies, asset classes and currencies. Diversification effectively mitigates portfolio risk while maintaining the same expected rate of return, resulting in a more optimal portfolio structure through the dispersion of risk across multiple investments. South Africa’s contribution to the global GDP stands at approximately 0.5%. Consequently, many South Africans have limited exposure to offshore investments. Typically, South Africans possess primary residences, with some also owning secondary vacation homes or investment properties within the country. Their employment is often centered in South Africa and some may even have their own businesses. Ultimately, the majority of their assets and income/salary are heavily concentrated within a single country. Irrespective of one’s country of residence or personal stance on a country’s economic growth, it is prudent to distribute risk across various asset classes, countries and currencies.

2. Foreign equity consistently outperformed the JSE stock exchange

The graph presented below illustrates the returns of different asset classes across multiple time periods. It is apparent that while foreign equity occasionally experienced brief periods of underperformance compared to other asset classes, it has consistently outperformed the JSE stock exchange over the last 5, 10 and 15 years in the long run.

Figure 1: Average unit trust category returns in South African rand (June 2023)

3. Since 2000, the rand weakened by 5% p.a. against the US dollar

The impact of the rand on various investments varies depending on the specific holdings and fluctuations in the rand’s value, known as currency risk, can have either positive or negative effects on portfolio returns. Taking into account how movements in the rand affect different components of an investment portfolio can help ensure the achievement of investment objectives despite currency volatility.

A depreciating rand generally benefits offshore investments. For instance, if one has savings in an offshore bank or engages in forex trading, a weakening rand relative to the invested currency would result in positive returns when measured in rand. In other words, if an individual purchases US dollars at an exchange rate of R14/US$, their return will be positive if the rand weakens to R20/US$ (indicating a weaker rand), but significantly lower if the rand strengthens to, for example, R7/US$.

The South African rand has experienced a consistent weakening trend against most currencies, with the US dollar (USD) appreciating by an average of more than 5% per year against the South African rand. In addition to offering diversification benefits, the USD has consistently outperformed the ZAR over an extended period of time.

Figure 2: USD/ZAR exchange rate since 01.01.2000 – 30.06.2023

4. Gaining exposure to growth opportunities

The equities listed on the Johannesburg Stock Exchange (JSE) constitute merely 1% of the global equity market capitalization. Consequently, investing solely in South African equities would result in missing out on 99% of the global equity universe. Offshore investments provide clients with the opportunity to access themes and sectors that are not readily available within South Africa, such as Cybersecurity, Robotics, Medical Devices, Technology, Smart Infrastructure, Genomics, Cloud Computing, Artificial Intelligence, Aerospace and Defence.

Residing in an emerging market like South Africa, diversifying into developed markets can prove highly advantageous. These markets are influenced by distinct macroeconomic factors, offer more stable growth prospects and grant exposure to various sectors with hard-currency exposure. Simultaneously, rapidly expanding emerging markets, particularly in certain Asian economies, present lucrative growth opportunities. By expanding one’s portfolio beyond the domestic market, the probability of achieving superior returns is significantly enhanced.

5. South Africa’s economic outlook remains weak

Continuous power outages, rampant crime, pervasive corruption and deteriorating national infrastructure have an immeasurable negative impact on South Africa’s potential for economic growth. Promised reforms often fail to materialize and the governing party’s public alliance with Russia raises concerns. Regardless of how the African National Congress (ANC) attempts to address these issues, any potential market revaluation (from currently depressed levels) is likely to occur only in the context of a stronger global economy and a weaker US dollar. Secondary sanctions, amidst heightened geopolitical polarization, have created reluctance among potential investors to allocate resources to the country.

South Africa’s greylisting status carries significant implications for economic growth and global competitiveness. Being greylisted means that all transactions involving South African companies and individuals are viewed as high-risk, resulting in increased compliance requirements, administrative burdens, and potentially discouraging investment and trade with South Africa. According to a report by the International Monetary Fund (IMF), greylisting leads to a significant reduction in capital inflows, and for vulnerable countries, it can even trigger a balance of payments crisis. South Africa could potentially be removed from the grey list within a period of two years if the government and the private sector collaborate to take decisive actions addressing the concerns raised by the Financial Action Task Force (FATF).

In 2022, South Africa experienced a record number of days with loadshedding. Calculations indicate that stage 6 loadshedding costs the country approximately R 200 million per day. The South African Reserve Bank estimates that loadshedding is responsible for a 2% reduction in the country’s GDP growth.

While there are still some opportunities in South Africa, we believe it is crucial for investors to allocate a substantial portion of their assets to global markets, considering the aforementioned threats. However, we acknowledge that a portion of an investor’s portfolio should still include South African assets.

Our solution

There are numerous favorable factors for South African investors considering long-term investments in global markets. At VEGA Asset Management, we offer a distinctive service that entails opening a Swiss bank account in each client’s name, which we then manage in terms of investment activities. Additionally, clients have the option to utilize the Swiss bank account for transactional purposes. Through this account, we can invest in most globally listed shares and hold cash in various currencies. Moreover, the account can serve as a platform for investing in a range of financial instruments, including structured products, bonds, and options, among others. The primary challenge for investors lies in not allowing short-term fluctuations in portfolio value to impact their decision-making. Rather than fixating on the daily share prices of companies, it is advisable to focus on factors such as revenue and earnings growth, profit margins and debt levels. These indicators provide a more reliable assessment of a company’s potential as a sound long-term investment.

In the words of Warren Buffet, “The stock market is a device for transferring money from the impatient to the patient.”

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Francois du Plessis, besturende direkteur van VEGA Batebestuur gesels oor vandag se markte, asook die VSA en Sjina se verhouding.

https://www.moneyweb.co.za/moneyweb-radio/rsg-geldsake/markoorsig-1321/

Artificial intelligence (AI) has transcended its previous abstract status and has emerged as a versatile technology with widespread applications across various domains, including healthcare, finance, advertising, and numerous others. The recent surge of interest in ChatGPT, a program specifically designed to enhance language models for conversational purposes, has intensified discussions surrounding the economic and societal implications of AI.

Figure 1:  Time to reach 1 million users for various digital applications

The magic behind the machine

The objective of artificial intelligence (AI) is to enhance the intelligence and utility of machines, resulting in improved efficiency and productivity. By employing AI judiciously, companies can gain a competitive advantage, gain deeper insights into customer needs, and ultimately experience increased revenues or reduced costs. While the rationale behind investing in AI is primarily based on structural considerations, the evolution of AI will be shaped by two key factors:

1. The availability of extensive data: The abundance of data plays a crucial role in the development and advancement of AI. As data volumes continue to grow significantly in the coming decades, the speed and accuracy of AI systems are expected to improve correspondingly.
2. Increasing computing power: The progress in computing power is another pivotal factor influencing the evolution of AI. Continued advancements in computational capabilities will contribute to the refinement and effectiveness of AI technologies.

However, concerns regarding data collection, security, and privacy have emerged, leading to a public debate surrounding these issues. Despite the optimistic outlook for the growth of computing power and data availability, the unresolved concerns related to data handling have added complexity to the AI landscape.

There are three clusters of companies that are expected to reap the benefits of artificial intelligence (AI):

1. Large technology companies: These companies are poised to be the primary beneficiaries of the widespread adoption of AI. They possess extensive expertise in AI, accumulated through years of substantial investment. As a result, they are well-positioned to introduce and market AI-enhanced products and services. Furthermore, these companies have significant financial resources, enabling them to swiftly invest and allocate capital in high-growth areas, such as AI, which constitutes a pivotal component of their future growth strategies.

2.  Software companies, cloud services, data analytics, and cybersecurity firms: The AI software market is projected to reach USD 192 billion by 2025, with a compound annual growth rate (CAGR) of 31%, according to IDC. Despite concerns about inflation and an impending economic downturn, spending on AI and automation technologies and solutions continues to surge, as stated by Ritu Jyoti, Vice President at IDC. Software companies, providers of cloud services, and firms specializing in data analytics and cybersecurity are well-positioned to capitalize on this growth.

3. Semiconductors: The expansion of cloud computing and AI is generating substantial demand for semiconductors, including computing units, memory, and other components specifically designed for AI applications. Industry estimates project that sales of AI-specific chips will reach USD 77 billion by 2025, a significant increase from USD 11.2 billion in 2021. This heightened demand will greatly benefit chipmakers and companies involved in the production of semiconductor equipment.

What are the risks?

AI presents several risks that need to be carefully considered. These risks encompass both sustainability concerns related to the job market and the environment, as well as reputational and regulatory risks associated with misinformation and the potentially harmful use of AI. It is crucial to acknowledge that AI and natural-language models are susceptible to errors, leading to the generation of misinformation. Moreover, they may also raise issues regarding data privacy, security, and intellectual property rights.

Additionally, AI introduces the risk of a significant rise in cyber attacks due to the increased ease of creating viruses, scams, and manipulating data. The accessibility of generative AI, such as ChatGPT, lowers the barriers for entry for cybercriminals. According to a survey conducted by research firm Baker McKenzie, CEOs identify cybersecurity as the most significant risk associated with the widespread adoption of AI.

Figure 2: 69% of US executives believe the biggest risk from AI is cyber attacks

The potential for automation through AI is substantial, with the capacity to replace repetitive and easily automatable tasks. This could result in job losses and a restructuring of the workforce to adapt to new roles. Numerous studies have attempted to quantify the global impact, estimating the number of jobs at risk.

The OECD suggests that 14% of jobs worldwide are susceptible to automation, while PwC and Goldman Sachs estimate the figure to be around 326 million and 300 million jobs, respectively. According to a McKinsey study, it is the activities performed within jobs that are more likely to be automated, indicating that existing technologies can already automate approximately 45% of activities in the US, equivalent to USD 2 trillion in wages.

The extent of job automation will depend on two key factors: the amount of time spent on repetitive tasks within an activity and the level of training and qualifications required for the task. Sectors such as transportation, logistics, manufacturing, retail sales, fast-food kitchen staff, secretarial roles, and counter staff are among those identified by the OECD as being at higher risk of job automation.

Which are the opportunities for investors?

Based on the analysis conducted by consultancy firm IDC, the artificial intelligence (AI) market has the potential to reach a value of up to USD 900 billion by the year 2026. This estimation encompasses various segments of the AI market, including hardware, software, and services. If realized, this projection would represent significant growth, as it would be twice the value recorded in 2022.

Figure 3: Estimated global AI market between 2020 and 2026e, in billion dollars

The significance of Artificial Intelligence (AI) became evident in the recent quarterly results of 1Q23, where references to AI during post-earnings conferences in the United States experienced a notable increase of 85% compared to the previous year. This substantial growth highlights the considerable interest and momentum surrounding AI within the private sector.

 Bill Gates, a notable figure in the field, emphasized that entire industries will undergo a reorientation process centered around AI. He further stated that companies will distinguish themselves based on their ability to effectively leverage AI and derive maximum benefits from its utilization.

Figure 4: Number of acquisitions of AI companies by major technology groups, between 2019 and 2021

Numerous enterprises are making substantial investments in artificial intelligence (AI) with the aim of enhancing their operational processes, services, and products. This is motivated by the transformative potential of AI, which can yield significant competitive advantages across various sectors. Prominent technology conglomerates, including Google, Microsoft, Meta, and IBM, are channeling billions of dollars toward AI research and development.

For instance, Google acquired DeepMind, an AI startup, in 2014 for a substantial sum of $600 million. DeepMind notably achieved breakthroughs in AI by creating the first model capable of defeating a world champion in the game of Go, as well as the AlphaFold model, which accurately predicts protein structures.

 Microsoft, on the other hand, has made a strategic investment of over $10 billion in OpenAI, the developer of the generative AI model known as ChatGPT. Microsoft is actively integrating AI capabilities into its range of products and services.

The world isn’t getting any safer and as long as that remains the case, there is going to be demand for defense companies and the products they manufacture. Defense stocks tend not to be as glamorous as tech stocks but provide reliable revenue and income. Defense stocks tend to be stable contributors to an income-focused portfolio, with predictable long-term revenue streams that translate into solid dividends.

The aerospace and defense industry plays a vital role in the global economy by supporting and facilitating passenger transportation, trades, logistics, security and defense. The industry consists of several players servicing both commercial and military operations across the value chain. These players include aircraft manufacturers such as Boeing and Airbus; part manufacturers such as GE Aviation, Lockheed Martin, BAE Systems and Rolls-Royce Holdings; and Maintenance, Repair and Overhaul (MRO) organisations which are the aftersales service providers. The majority of these large firms are located in the United States of America which accounts for 49% of the total industry value.

Figure 2: Space economy and its subsectors/themes forecast up to 2040

According to Morgan Stanley (MS), the current market value of the space economy is $350 billion and is expected to grow to $1 to 1.5 trillion in 2040 or a 5,3% annual compounded growth rate over the 20-year period from 2020 to 2040.

The figure 3 shows the annual average US military spending by war vs US military aid to Ukraine (in $bn’s). It is astonishing to see that the aid to Ukraine exceeds America’s spent in the Afghanistan war. Important to note, military aid does not include weapons and equipment.

No one of the defense contractors gives exposure to the entire industry. Therefore, it might make more sense to invest in the defense sector through an exchange-traded fund (ETF).  As a result, we prefer to have exposure to the aerospace and defense sector via the iShares U.S. Aerospace & Defense ETF (ITA), which is also the largest ETF focused on defense, with $4.7 billion in net assets as of early December 2022. This ETF is designed to provide exposure to domestic United States aerospace and defense companies, as well as exposure to the commercial aerospace industry.

Figure 4: iShares U.S. Aerospace & Defense ETF (ITA) top 10 holdings (%)