3 Reasons To Invest In South Africa

If you’re an active investor (i.e., an investor who selects where and when to invest in an attempt to beat the market), then you should probably visit the country to conduct some thorough due diligence, you’ll be impressed with the investment potential of this country.

Here are some valid reasons why you should:

Reason #1: Reduce Home Bias

Many studies report evidence of a home bias in investors’ portfolios. That is, investors tend to concentrate their investments in their home country, and therefore, be underdiversified globally. This underdiversification can increase the riskiness of investors’ portfolios and lower their expected returns.

Reason #2: Global Diversification Improves Portfolio Performance

The beauty of global diversification (i.e., reducing home bias) is that investing in countries that look risky in isolation can actually lower the riskiness of an investor’s portfolio. The key to this “magic” is that security returns in different countries don’t move in lockstep. For example, when the U.S. stock market was down 22% in 2002 following the Dotcom Bubble and the 9/11 terrorist attacks, the South African stock market was up 49% (both indices come from Datastream and are based on U.S. dollars).

Although the South African market doesn’t always rise when the U.S. market falls, the fact that the two markets aren’t perfectly correlated means that investing in South Africa can improve your portfolio’s performance. In other words, for a given level of risk, you can expect to receive a higher portfolio return when you diversify into South Africa (as suggested in Reason #1).

Reason #3: Efficient Financial Markets

South Africa ranks high worldwide for investor protection and the extent of disclosure. These characteristics enhance the efficiency of the country’s financial markets. And the more efficient markets are (e.g., the more securities are correctly valued based on fundamentals such as plausible forecasts of future cash flows), the more investors can count on the benefits of global diversification. For example, if an international market is overvalued, then the diversification benefit of investing in that market can be offset by the unjustifiable price premium investors must pay. This possibility is minimized with investments in South Africa given the efficiency promoting characteristics of the country’s financial markets.

How Much Should You Invest In South Africa?

There’s no consensus on the precise amount to invest in South Africa (or any other countries). However, the Vanguard Total World Stock Index Fund provides an all-in-one low-cost means of fully diversifying your equity investments across the world. For bonds, a combination of the Vanguard International Bond Fund—which includes bonds from South Africa along with many other countries except the United States—and the Vanguard Total Bond Index—which focuses on bonds from the United States—can provide full diversification across the world bond market. Although there’s no consensus on the correct combination of these bond funds, 50/50 is a good default option. (Note: I have no incentive to recommend Vanguard funds. I’m only mentioning them because I’m familiar with them and personally invest in them.)

Do You Need To Visit South Africa?

One of the many advantages of the index investing approach to international diversification is that there’s no research or any other work required beyond acquiring the knowledge of how to implement this approach. This means it’s not necessary for you to visit the countries in which you’re investing.

Still, although a visit to South Africa won’t improve your portfolio performance if you’re an index investor, but it will improve your life. South Africa is a country with gorgeous weather and beautiful landscapes (think Los Angeles sans the earthquakes and bad NFL teams). Most importantly, South Africans are a warm and welcoming people. For these and many other reasons, I think you will enjoy a visit there. And you’ll enjoy it even more knowing you’ve invested wisely in the country.

Written by GR

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