The Exchange Rate And Your Investments

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There are many important considerations when investing offshore, but investors often tend to focus their attentions exclusively on the Exchange Rate. Many are reluctant to invest when the Rand has weakened. The benefits of investing offshore often tend to outweigh potential gains made by trying to time the investment decision.

Exchange Rate Impact Explained

Changes in exchange rates may not seem to affect most people in their everyday lives, but indirect effects are more widespread than many realize.
When exchange rates change, the prices of imported goods will change in value, including domestic products that rely on imported parts and raw materials. Exchange rates also impact investment performance, interest rates and inflation – and can even extend to influence the job market and real estate sector.

Exchange rate fluctuations can have a substantial impact on your investment portfolio, even if you only hold domestic investments. For example, the strong dollar generally dampens global demand for commodities as they are priced in dollars. This lower demand can affect earnings and valuations for domestic commodity producers, although part of the negative impact would be mitigated by the weaker local currency.

How To Start Investing Offshore

You have two options when it comes to investing offshore. You can invest offshore indirectly if you invest in a fund priced in Rands. The other option is to invest directly into international funds that are priced (usually) in US Dollars, UK Pounds or in Euros. 

Understanding Exchange Rate Risk

When you invest in a fund, you buy units in the fund. These units have a Rand value. A good example would be, let’s say you buy 1000 units at 1 USD each. The exchange rate is R17 per USD, and your total cost is R17 000. In this table, you will see the Rand value of your investment (1000 units) for different changes in price and exchange rate:

Scenario 1:

There is no change in the unit price of the fund in which you invest. The Rand has weakened against the Dollar from R 17 / USD to R 19 / USD. The Rand value of your investment is now more:

1 000 units X $ 1.00 X R19 / USD = R 19 000

PROFIT = R 2 000

Scenario 2:

The unit price of the fund in which you invest is growing in value from $ 1,00 to $ 1,10. The Rand has weakened against the Dollar from R 17 / USD to R 19 / USD. The Rand value of your investment is now more:

1 000 units X $ 1.10 X R19 / USD = R 20 900

PROFIT: = R 3 900

Scenario 3:

There is no change in the unit price of the fund in which you invest. The Rand strengthens against the Dollar from R 17 / USD to R 15 / USD. The Rand value of your investment is now less:

1 000 units X $ 1.00 X R15 / USD = R 15 000

LOSS = R 2 000

Why Is It Important For South Africans To Invest Offshore

Over the past 10 years, the exchange rate has depreciated by +/- 120% (R 7.58 / USD – R 16.74 / USD). This is equal to -8,25% per annum.
If this continues and offshore equity increases over the long term, scenario 2 above will apply.

When global sentiment towards emerging markets improves and commodity prices rise, capital flows increase, and the rand will tend to appreciate with its peer currencies. The opposite is also true.

When talking about ‘the rand’, most people refer to the rand-US dollar exchange rate. It is by far the most important currency pair for South Africans. Our commodity exports are priced in US dollars, as is oil, our main import. More than 50% of global equity market capitalisation is also in dollars, meaning that it has an outsized role in portfolios too. Other notable currency pairs are rand-euro, rand-pound and rand-yen.

To state the obvious, an exchange rate has two moving parts, the rand and the dollar, for instance. It is possible for the rand to strengthen against the pound and weaken against the dollar, such as when Brexit risks weighed heavily on the pound. But it is unusual. Being an emerging market and commodity currency, the rand will tend to move in the same direction against the major currencies. It tends to move in line with its emerging market peers, as indicated on the chart below:

Source: Refinitiv Datastream

While there are some South Africa-specific issues at play, changes in global financial conditions are more important. They determine the general trend in the rand – the direction of the tides.

So what is the shorter-term outlook?

The rand experienced a classic blow-out in the first few months of 2020, as global COVID-19-related risk aversion gripped the world. What these episodes – spring tides – also have in common is that the rand strengthened significantly in the following months. So while the long-term trend (i.e. over decades rather than years) is for the rand to weaken in line with the difference in inflation rates between the US and South Africa (according to the theory of purchasing power parity), in the shorter-term it can strengthen appreciably. 

Consider the following 

  • Your purchasing power should be measured in the currency that you do most of your purchasing in.
  • It makes sense to match shorter-term spending needs with SA interest-bearing assets, particularly with high local long bond yields.
  • Putting your entire portfolio offshore might work over the very long term, and would have worked over the past few years, but there have been uncomfortably long periods when this would not have worked (most notably between 2002 and 2006). And you would miss out on attractive local investment opportunities.

Your Investment Strategy

Consult an Independent Financial Adviser for advice on how you can invest offshore. It is important to take a holistic view of how your offshore investments will fit into your total investment portfolio. You should also consider which asset classes will be most appropriate for your investment goals.
Our Independent Financial Advisers specialise in matching your needs with the right investments. They have access to a wide range of international asset managers, investment administrators and forex services.

 

Reach out and start diversifying your investment portfolio with our specialists.

Phone: +27 21 914 7480

Cell: +27 82 893 2795

Email: info@tvc.co.za

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Read More:

Asset Classes Explained

How To Start Investing Offshore

What does it mean to invest in an investment fund?

When is the best time to invest offshore?

Exchange rate exposure: A hardy perennial

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