Benchmarking an allocation to the foreign Sub-portfolio from a South African perspective

This paper responds to the recent (2022) change to Regulation 28 of the South African Pension Funds Act which now permits an increased allocation (raised from 30% to 45%) in foreign investments. Our primary aim is to establish a strategic (long-term) benchmark weight for the allocation to foreign assets. Our secondary aim is to assist in building intuition on potential tactical (shorter-term) foreign allocation decisions. To ensure rigour in our study, we use a novel dataset dating back to the 1930s and we utilise methodologies in recent academic literature in the mean-variance framework. Our optimisation evidence supports a strategic foreign benchmark allocation of 39% (with 61% allocated to local asset classes). We highlight that this strategic foreign benchmark of 39% (probably for the first time) enables managers to potentially take on meaningful tactical overweight foreign positions. We establish that this strategic foreign benchmark would have reduced the risk (standard deviation of returns) of the local-only optimal portfolio significantly from 10% p.a. down to 8.7% p.a. over the 92 year period analysed, whilst increasing the return by an additional 1.1% p.a. over the local-only portfolio. Lastly, we provide guidance on tactical foreign allocation decisions based on four potential local economic regimes.