An Alternative Approach To Currency Hedging
When we consider investing overseas, investors are often focused on one major risk that they do not face when investing in their home country: currency risk. Indeed, this often deters, dare I say scares, investors from making what would otherwise be solid investments. Is it the case that currency concerns need to stop us from investing internationally? Here are three considerations when examining currency risks.
One: Am I investing in developing or developed markets (and what is my timeline)?
You may be surprised to know that for example the US dollar index (a measure of the value of the U.S. dollar relative to the value of a basket of currencies of the majority of the U.S.'s most significant trading partners) is at the same approximate level as it was 50 years ago (click here to learn more). There have of course been large movements during the 50 year period. The point here is, if you are investing in a mixed basket of currencies, and if you have a significant timeline, currency considerations may not make sense as your major investment driver.
If you are investing in developing markets, you can take the following approach:
1) investing in your local currency (or at least USD, which is of course more stable against the Euro if you are investing from Europe),
2) you can choose only to invest in emerging markets with relatively stable currencies, such as China or Nigeria,
3) you can invest in a basket of countries that on average have a relatively stable relationship to the dollar. For example, the Thai Baht has appreciated 15% against the US dollar over the last five years (and is relatively equal over a ten year period), and you may choose to invest in Thailand along with another country whose currency has depreciated slightly, giving you an overall stable currency profile, or
4) invest in the local currency, but factor in the costs of hedging (which can be significant) into your investment. You also need to consider that hedging over a long period (more than two, maximum four, years) can be almost cost prohibitive.
Two: Where are my funds going after investment?
Beginning with the end in mind is always good advice. What are my plans for these funds? Are they impact funds focused on that country, or that region? Do I expect them to be repatriated to my home country? If I am planning to continue to invest within that country, or that region, then investing locally offers me the opportunity to start to see impact and returns now (and perhaps deepen my local resources as I put more capital to work over time). If I need the funds returned to my home country, then I need to consider whether the best approach is a hedge or rather an investment in certain countries or a basket of countries.
Three: How global are my investment priorities?
If you are a global investor, then you may be able to shift your investment proceeds from one country into another country where instead of taking a loss, the currency shifts actually increased your investment. For example, over ten years, the Kenyan Shilling has depreciated against the British pound by 9%, but has appreciated against the South African Rand by 75%. In that case, if you are investing in pounds, and have a global portfolio as your goal, then you may consider reinvesting your returns into South Africa (as an example), instead of repatriating them to the UK.
Concern around currency effects on investments need not scare off international investment. In addition to traditional hedging, there are a variety of other ways to look at global investing as outlined above. At Lighthouse, we analyze potential investments from the investor’s perspective, helping the investor to consider their own goals and needs so that we can tailor a transaction to suit their goals.