IN A NUTSHELL: Retirement funds can add another level of diversification to their investment portfolio by investing in fixed-income funds in other countries.
As in South Africa, other countries offer various fixed-income instruments and funds, commonly referred to as offshore fixed-income funds. The major difference between domestic and offshore fixed-income investments is the issuer’s location. Domestic fixed-income investments are issued within your country, while offshore investments involve bonds or debt instruments issued by foreign governments or companies, for example, a South African retirement fund that buys treasury bonds in the United States or invests in a global fixed-income fund based in Europe.
Some fixed-income funds might invest in a mix of domestic and offshore bonds, while others invest in bonds in various countries and currencies.
What about Regulation 28?
In terms of Regulation 28, retirement funds may invest up to 45% of their portfolio in offshore assets, up to 10% of which may be allocated to Africa outside of South Africa. The fund’s trustees or investment managers must ensure that offshore investments, including global fixed-income funds, fall within these limits.
Offshore fixed-income funds provide retirement funds with the opportunity to diversify their fixed-income allocation and overall portfolio. This approach spreads risk across various debt instruments within South Africa but also extends diversification across international borders and multiple currencies.
How can retirement funds invest in offshore fixed-income funds?
A retirement fund can invest directly in a global credit fund via an investment manager. The investment manager typically handles the necessary currency conversions (e.g. euros or dollars) and transfers, ensuring the transactions align with the fund’s requirements.
Global credit funds typically invest in debt instruments denominated in various currencies to achieve diversification. While these funds may have a base currency (e.g. euros), they often include investments across multiple currencies.
Some investment companies offer “feeder funds” where investors can use rands. Investors do not need to set up a euro- or dollar-based account; they can invest in rands, and the feeder fund also pays out in rands. These rands are converted into other currencies within the feeder fund, which are then used to purchase units in a global fixed-income fund also managed by the investment company. Essentially, it allows investors to use their offshore investment allowances to access global credit without the complexity of managing foreign currency accounts.
In conclusion, by investing in global credit funds and feeder funds, trustees can enhance their fund’s performance through well-managed exposure to global credit markets while mitigating risks through currency and geographic diversification.
Debt investing: debunking the myths
Investing in credit in various currencies and countries can leave trustees feeling overwhelmed. In our modern era of information overload, there is a lot of noise concerning fixed-income funds that is not necessarily true. Paul Crawford, Fairtree Fixed Income Portfolio Manager, clears up some of the most common myths.
1 Credit is too risky; you will lose money
Credit carries some risk, but the idea that you will inevitably lose some of your capital is not a given. Many fixed-income funds have done the opposite and have shown capital gains over time. Even with the ups and downs of credit markets and regular dividend payouts, these funds have shown stable growth, proving that credit does not automatically mean loss.
2 Do not invest in credit; defaults are rising
Despite concerns, research has shown that global defaults have not increased significantly in recent years. Global credit markets have shown resilience. The fear that defaults are spiralling is not true. At some stage, defaults will increase, but they will not happen overnight.
3 High interest rates mean more defaults
Many believe rising interest rates lead to more companies failing to repay their loans, but there is no direct link between them. Even in times of high interest rates, well-managed credit portfolios have remained stable and performed well.
4 My investment can be wiped out overnight
There is the belief that investments can be wiped out without any warning. In most instances, defaults are anticipated and reflected in bond prices before they happen. By the time a default occurs, the market has usually adjusted, minimising the impact on the overall portfolio. In well-diversified funds, defaults have a minimal effect. So, while defaults do happen, they are rarely catastrophic.
Look out for side-pocketing
Side-pocketing is when a fund manager separates and transfers an asset from the main fund into a separate newly created side-pocket fund. Why? The asset could be illiquid, hard to value, or highly risky, like bonds issued by companies in financial difficulty or governments of politically unstable countries. Side pockets, also called retention funds, are legal and must be approved by the Financial Sector Conduct Authority. However, trustees need to understand how side-pocketing is used within a fund. It should be a red flag as the fund’s true value could be less than the reported value.
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