What Currency Movements Mean For Your Investments
The world now, more than before, is facing some structural changes with will propel currencies movement. Previously, currencies of the world have been affected by economy, interest rate and investor usage. Now the movements of currencies will be broader in a clearer direction. With Singapore Dollar going to be strong, whole reason why knowing what to do is important.
So what do these currency movements mean for investors’ investments? A lot of investors (sadly a lot of financial advisers, even bankers too) make mistakes when determining where the currency matters and where it does not. For example, you can hear an investor, or financial adviser, saying, “I’m not advising this fund because it is in USD. USD is going to depreciate.” This reasoning is WRONG.
Let’s go through a few of the terms.
Appreciate – To raise in value or price, especially over time.
Depreciate – To diminish in price or value, especially over time.
Three areas where currency affects the investment in funds -
1. Currency which you (the investor) earns and spends in. Everything will have to be converted back to this currency to get final profit & loss
2. Currency the fund use as the accounting currency. This is the working currency of the fund. This will be converted into the necessary currencies to buy the underlying assets and in event of liquidation, this is the currency given to the investor.
3. Currency the underlying assets is measured in. The fund have to use to buy or sell the underlying assets.
First Example
A Singaporean, earning and spending Singapore Dollars, SGD. Buys a fund in SGD. And the fund is invested in US companies, which means underlying asset is in US Dollars, USD. Assuming that the USD is depreciating over the long term, what is the effect? Firstly, how does the currency of the underlying assets affect the fund price? For prices of the US stocks in USD remaining constant, the depreciation of the USD will lower the fund price in SGD. Secondly, since the investor are earning and spending in SGD, the appreciation or depreciation of the fund currency SGD has no effect on the investor.
Second Example
A Singaporean, earning and spending SGD. Buy a fund in USD. And the fund is invested in China companies, which means underlying asset is in Chinese Yuan, CNY. Assuming the CNY will appreciate and USD will depreciate in the long run. Firstly, for prices of the Chinese stocks in CNY remaining constant, the appreciation of the CNY will increase the fund price in USD, which is simultaneous depreciating. Secondly, since the investor is earning and spending in SGD, you will need to convert the fund currency in USD back to SGD. You can see that how much the investor gain or lose depends on the gains/loss from the conversion from CNY to USD and gains/loss from the conversion from USD to SGD. Therefore, the real determinants of gains and loss is the exchange rate between CNY and SGD. USD is just the accounting currency, you can use seashells for the accounting and the result is the same.
(Do note that the stock price of companies will be affected by the appreciation and depreciation of the currency the company uses as accounting currency depending on the business and assets. This is out of the scope of the discussion here.)
How do you protect against currency movements?
So you will be asking now. With the market consensuses that USD and Euro, EUR, will be weak, CNY will be allowed to appreciate and SGD will be strong, what can investors do to protect their investments? Firstly, for most Asia equity, the strong Asian currencies will be likely in investors’ favor, regardless the accounting currency. Secondly, for investments in areas where there is potential but the currencies will be weak in the long run, investors need to hedge the currencies. Many funds offer SGD hedged classes, which means capital gains made in USD or EUR will not be wiped out by SGD appreciation and concurrent USD and EUR depreciation.
There are some instruments in USD and EUR which investors should reassess the needs and advantages though. They are endowments and insurance policies. These policies promises an insurance coverage and/or payout in the respective currencies. However, converting SGD to USD now and receiving USD some years down the road, investors will find that the gains in SGD will be severely diminished.
Hope this helps clear some misconception. Do contact me if you have any questions or drop me a comment.
2 Responses to “What Currency Movements Mean For Your Investments”
Leave a Reply
What about insurance policies in USD? How does this affect my returns when I’m getting back the proceeds or investemtns?
Hi Kim Chong,
it really depends on what insurance policy it is. Endowments, Investment linked policies or Whole-life (limited pay or not). What I am sure is that if the policy is entered into some years ago, Singapore dollar (SGD) had been converted to US dollars (USD) all these years at a much higher rate. Sum assured in USD converted to SGD will definitely be lower. If the USD in cash value is not placed in meaning investments it will be hurt by depreciation. (it is usually not possible to determine what is invested except for ILP)
Example of a policy at the losing end is an simple endowment policy. 20 years policy starting from around 2000, a USD100,000 endowment policy would have lost out in terms of SGD as USDSGD was 1.75-1.80 then, compared to 1.31 now. The premium and target in USD are still the same, however target converted to SGD will be lower when eventually matured and Premiums were much higher in SGD since the time it was started.
Of course, those are sunk costs. What is important for decision is where it will be heading. I believe the USDSGD will continue to creep lower, mostly due to SGD appreciation on inflationary pressures.
Marco