Offshore investing is a powerful strategy to preserve and grow your wealth. It allows you to spread investment risk across different economies and geographies. It also provides access to industries and companies that may not be available locally but are an important component of a well-diversified portfolio.
Background
Offshore investing is a powerful strategy to preserve and grow your wealth. It allows you to spread investment risk across different economies and geographies. It also provides access to industries and companies that may not be available locally but are an important component of a well-diversified portfolio.
Broadly, there are two options for investors when investing offshore:
In this article we briefly recap the main benefits of a feeder fund and discuss why the indirect route may be underrated. The financial and/or investment situations of investors are all different and feeder funds certainly cater for investors with specific needs.
Less complex
Feeder funds are very simple. Investors do not need to purchase foreign currency – if you invest in a rand-denominated offshore unit trust, you get offshore exposure from a locally held investment. This means that although you invest in rands, your investment returns are generated from shares, bonds, property and cash, which are held offshore. Investment performance is based on the performance of offshore markets, rather than local markets. In addition, investors do not need a Tax Clearance Certificate.
Unlimited offshore exposure for minors
Investors can also invest offshore on behalf of their minor children via a feeder fund. Only South African resident taxpayers over the age of 18 qualify for the direct offshore option. This includes a Single Discretionary Allowance (SDA) of R1 million and a Foreign Investment Allowance (FIA) of R10 million. Thus, a feeder fund allows you to start investing offshore, on behalf of your children, from a young age.
Minimum amounts…cater for smaller investors
Typically, when it comes to indirect investing the barriers to entry are much smaller. This makes feeder funds accessible to smaller investors that may not be able to afford the relatively high lump sum required to invest directly offshore, which can be as high as US $50 000. Not only is the lump sum amount much smaller, but you are also able to invest monthly, typically from R500 to R1 000 p/m. Foreign-domiciled funds do not generally offer monthly debit orders and those that do, still require a large amount, typically up to R20 000 p/m, which again may not be accessible to smaller investors.
Be disciplined …apply your annual R40 000 exemption for CGT
The disadvantage of a feeder fund is that currency gains are also subject to Capital Gains Tax (CGT). In a rand-denominated fund, any currency* gains when you sell units from your Collective Investment Scheme (CIS) (‘unit trust’), would attract CGT. The impact of this could be significant considering that the current inclusion rate for CGT is 40% and not the 10% rate that was appliable when CGT was first implemented.
There is, however, a way to reduce the CGT payable. It requires investors to be disciplined and use their annual CGT exemption, being the first R40 000 of gains made on their discretionary portfolio, to annually reset the base cost. This would involve selling units to the value of R40 000 and immediately buying back those units at the same market price – ‘buy and sell’. This allows investors to ensure future CGT payable is substantially less, when eventually selling units to fund his/her investment goals. See the example that follows.
TFSA… eliminates CGT on currency gains
It is important to remember that when you invest in a Tax-Free Savings Account (TFSA) you are not liable for any taxes. Hence, do not underestimate the huge tax saving available.
When investing in a TFSA, do not misallocate your lifetime allowance of R500 000. What does this mean? At present, investors benefit from an annual-tax free interest exemption, which is currently R23 800 per year for individuals under the age of 65. At current money market rates between 7% and 8%, an investor can keep approximately R300 000 in a traditional fixed income account/fund before paying any tax on the interest. Thus, investors should rather use their TFSA for longer term goals. A growth portfolio such as a global equity feeder fund is ideal to optimally make use of the tax-free savings on offer. These savings can be quite handy over the long run if you consider that you pay 20% tax on dividends and capital gains tax of up to 18% on discretionary savings that are not invested in a TFSA.
Post retirement - extra offshore capacity for your living annuity
It is important to note that the underlying assets in a living annuity wrapper are not regulated by Regulation 28 of the Pension Funds Act. This means that you can structure your underlying investment portfolio to achieve as much offshore exposure as is necessary for your strategy. However, this can only be done on an indirect basis and not through direct foreign investment. Direct offshore investing is not permitted within a living annuity, which is why indirect offshore investing is an excellent way of obtaining additional offshore exposure if needed.
Conclusion
Offshore investing can be an effective way to diversify your investment portfolio and should be considered as part of a holistic financial plan. However, it is important to understand the different options available, and the risks involved before investing. When deciding on the best approach for offshore investment exposure, both direct offshore funds and feeder funds have their advantages, depending on individual needs and preferences. Global feeder funds present a compelling option – not only do they provide an effective, more simple way to achieve international diversification, but they provide smaller investors with the opportunity to invest offshore.
Lastly, it is essential for investors to conduct thorough due diligence and consider consulting a financial adviser to identify the most suitable feeder fund(s) that align with their investment objectives.