THEONIEL MCDONALD: Concentration risk: what SA investors have learnt the hard way

Investors worldwide are navigating a period of heightened volatility, much triggered by geopolitical developments such as the Trump trade tariffs and retaliatory measures from major economies such as China. For South Africans, the turbulence is intensified by domestic political instability, particularly the recent fallout in the government of national unity after the DA’s decision not to back the ANC’s proposed budget.

But the unease runs deeper than short-term market corrections. It raises fundamental questions about the long-term sustainability of our country and such uncertainty often drives emotional, short-sighted investment behaviour. In volatile times like these the most prudent approach remains a well-diversified portfolio with balanced exposure across local and global assets. We are often led to believe that “this time is different”, yet history consistently shows us that cycles repeat and investor pitfalls remain the same.

SA investors in particular face a recurring challenge: concentration risk. Whether through overexposure to certain asset classes, sectors or currencies, this lack of diversification can magnify the effects of both sharp downturns and long-term economic decline. 

Concentration risk refers to the potential for significant loss arising from overexposure to a single investment, sector or geographic region. It is the inverse of diversification, which involves spreading investments across various asset classes and regions to mitigate risk. By contrast, a concentrated portfolio carries disproportionate exposure to one area, leaving the investor vulnerable to sector-specific or regional downturns. Several behavioural drivers can lead to this risk.

At times, it’s the result of popular investment trends. Think of the property boom of the early 2000s, the more recent rush into cryptocurrencies or reactionary moves to externalise capital during periods of heightened political fear. In other cases investors gravitate towards the familiar: assets linked to their profession, hobbies or local markets. Regardless of the motivation, the risk is the same: an unbalanced portfolio can leave you exposed when markets shift. 

Let’s take a closer look at one example that has affected many SA investors in recent decades: residential property. In the early 2000s declining interest rates, coupled with the popularity of books such as Robert Kiyosaki’s Rich Dad, Poor Dad, fuelled a widespread belief that property was the easiest path to wealth creation.

The ability to leverage debt, borrowing to buy a property and using rental income to cover the bond, seemed a foolproof strategy. But fast forward 20 years and the picture looks different. Outside the Western Cape, property prices in many provinces have stagnated, weighed down by poor service delivery, rising municipal rates and taxes and persistent crime.

Investors who concentrated their retirement strategy in this space have often seen returns that failed to keep pace with inflation. Selling in this environment can also prove difficult without price cuts. While property itself is not inherently a poor investment, overexposure to a single location or subsector can carry severe consequences, clearly illustrating the dangers of regional and sector-specific concentration risk. 

Another common form of concentration risk arises when an individual’s wealth is tied almost entirely to their own business. While it is true that investing in your own enterprise often yields the highest returns, particularly given your direct control and intimate knowledge of the business, this approach carries risks. Business owners frequently estimate future retirement wealth based on growth projections of 10%-15% per year, leading to seemingly impressive valuations.

However, this value is only realised if the business can be successfully sold, which is often much easier said than done. Numerous factors can erode or delay that value realisation, including increased competition, shifting market demand, regulatory changes or a personal health crisis.

Add to that the difficulty of finding a suitable buyer with both the interest and capital to acquire the business, and the risk becomes clear. Relying solely on your business for retirement capital can leave you vulnerable to a range of uncontrollable events, again highlighting the importance of diversification, even for entrepreneurs. 

A final example that affects many investors is the geographic allocation of their portfolios, whether through having the majority of their assets in their country of residence or allocating too much offshore. In both examples we see how investors can become exposed to geographic concentration risk.

It is important to recognise that SA is a small and vulnerable developing economy. Even when we make all the right investment decisions, events beyond our control such as a global pandemic or international trade disputes can have a devastating effect on local markets. Having a reasonable portion of your portfolio invested globally can provide valuable protection against a rapidly weakening rand.

One should also avoid excessive exposure to offshore assets, as these tend to be more volatile due to currency fluctuations. After Nelson Mandela’s presidential term ended many investors were persuaded to externalise their assets, fearing that SA would decline.

Yet the opposite occurred. The country entered a period of strong economic growth, the rand appreciated and local equity and property markets reached record highs. Meanwhile, global markets struggled. The main takeaway is that geographic diversification must be carefully balanced and guided by sound principles, not fear or speculation. 

The solution is often not a dramatic switch but rather a series of intentional, incremental changes that gradually optimise the portfolio. For property owners this might involve selling one or two properties and externalising a portion of the proceeds. For business owners it could mean allocating part of their cash flow to other investment vehicles. For those with a heavy bias towards local assets it may be time to start building a well-considered offshore portfolio.

Every investor’s situation is unique and seeking the guidance of a qualified financial planner can make a difference in navigating these decisions with clarity and confidence. 

• McDonald is head of financial planning at Carmel Wealth, senior adviser at Wealth Associates, and a director of the FIA.