Offshore investing – weighing up feeder funds versus direct investment offshore

*This content is sponsored by Investec Asset Management 

By Paul Hutchinson* 

Given the compelling reasons for investing offshore, a key question is how best to do so?

To date, many investors have favoured rand-denominated feeder funds because of the perceived complexity of applying for tax and Reserve Bank clearance to invest offshore directly. However, for discretionary investors (as opposed to investing via a retirement fund or living annuity product wrapper) the tax consequences favour investing directly offshore, not via a rand-denominated feeder fund, with the obvious exception of tax-free savings accounts. This is because, when you disinvest from an offshore fund, i.e. a US dollar-, pound- or euro-denominated fund, you calculate any capital gain in the applicable foreign currency (dealing currency) and multiply that gain by the rand exchange rate on the date of disinvestment.^[1] So, if your initial investment of US$10 000 has grown to US$20 000, your capital gain is US$10 000, which is then multiplied by the current exchange rate. Therefore, the rand/US dollar exchange rate at the time that you made the initial investment is irrelevant in determining your capital gain, i.e. you are not subject to capital gains tax (CGT) on any rand depreciation.

Table 1: Simple example of the capital gains tax calculation when investing in an offshore fund

However, if you invest in a rand-denominated feeder fund, any rand depreciation that impacts the valuation of the offshore assets in which that fund is invested, contributes to your capital gain. Therefore, you will be subject to CGT on both the capital growth of the underlying assets in which the fund is invested and rand depreciation.

Table 2: Key differences between investing in a rand-denominated feeder fund versus a foreign-domiciled international fund

A practical example

To illustrate the respective after capital gains tax return, we have compared an investment of R1 million into the Investec Global Strategic Managed Feeder Fund on 1 August 2013 with the US dollar-equivalent investment (US$101 770) into the Investec Global Strategic Managed Fund. At the time, the rand was R9.826 per US dollar.

Figure 1: Investec Global Strategic Managed Feeder Fund

Amount invested (Rand) R1 000 000 Value (Rand) after 5 years R1 663 887 Gain (rand) R663 887 Annual exclusion (assuming not already used) R40 000 Net gain after exclusion R623 887 CGT (18% assuming maximum marginal taxpayer) R112 300 End net value (Rand) R1 551 587

Past performance should not be taken as a guide to the future; losses may be made. Source: Morningstar and Investec Asset Management calculations, as at 31.07.18.  Performance figures are based on a lump sum investment, NAV to NAV, net of fees, for illustrative purposes only.  

Figure 2: Investec Global Strategic Managed Fund

Amount invested (US$) $101 770 Value (US$) after 5 years $129 134 Gain (US$) $27 364 Gain converted to rand (R13.1805 @ 31 July ’18) R360 671 Annual exclusion (assuming not already used) R40 000 Net gain after exclusion R320 671 CGT (18% assuming maximum marginal taxpayer) R57 721 End net value (Rand) R1 644 330

Past performance should not be taken as a guide to the future; losses may be made. Source: Morningstar and Investec Asset Management calculations, as at 31.07.18.  Performance figures are based on a lump sum investment, NAV to NAV, net of fees, for illustrative purposes only.  

The result, is a difference of R92 743 for investing in the dollar version of essentially the same fund. Money in one’s pocket trumps simplicity and relative ease!

The performance of the rand is a key consideration

The above analysis illustrates that the performance of the rand is a key contributor to an offshore investment’s overall rand return. Rand depreciation adds to the offshore investment’s return calculated in rands, and rand appreciation detracts from the overall return.

Figure 3 shows that since 1994, over rolling five-year periods, the rand has experienced periods of both depreciation (81% of the time) and appreciation (only 19% of the time) against the US dollar. On average, however, the rand has depreciated by approximately 6% per annum over rolling    five-year periods.  

Figure 3: Rolling five-year performance of the rand (May 1994 – July 2018)

Ease of investing offshore

Investors can now invest up to R1 million annually in an international fund without the need for any prior approvals. In addition to this annual discretionary allowance of up to R1 million, investors have a foreign capital allowance of up to R10 million per calendar year (a total sum of R11 million). Investors need to obtain foreign tax clearance from the South African Revenue Service when they wish to utilise their foreign allowance of R10 million, which should be forthcoming if their tax affairs are up to date. Reserve Bank approval is only required when investors wish to transfer funds offshore in excess of the maximum total lump sum of R11 million per calendar year.

As always, the best approach is to seek professional financial and tax advice.

• Paul Hutchinson is sales manager, Investec Asset Management

Reference funds: annualised returns (%)

Source Morningstar Direct, dates to 31.07.18, NAV based (net of fees, excluding initial charges), gross income reinvested, in US dollars (Investec Global Strategic Managed Fund) and ZAR (Investec Global Strategic Managed Feeder Fund).  Highest and Lowest refers to the highest and lowest 12-month rolling performance figures.  Highest: 44.3%, Lowest: -39.4% – Investec Global Strategic Managed A Acc share class (10 years). Highest: 45.2%, Lowest: -25.5% – Investec Global Strategic Managed Feeder A class (since inception:02.09.03). The total expensive ratio and transaction cost for the Investec Global Strategic Managed Feeder A is 2.21% and 0.08%, respectively.  *Pre 31.12.2010: 60% MSCI World NR, 40% Citigroup WGBI.

[1] You can also use the average exchange rate in the year of disposal.