If you invest offshore, have you considered currency risk?
If you're a South African investor who invests money offshore, either via a fund or directly, you have exposure to currency risk.
So what exactly is currency risk? And what do you need to consider?
Read on to find out…
What is currency risk?
As a South African investor, currency risk
means that your investment returns depend on how the rand performs against foreign currencies.
Let’s look at a quick example…
If you buy US shares, the dollar’s performance will have an impact on your returns:
If the dollar rises against the rand, your US investments are worth more in rand terms.
If the dollar falls against the rand, your US investments are worth less in rand terms.
But currency risk can be a bit more complicated than that.
Let’s say you bought European shares through an exchange traded fund (ETF) that’s priced in dollars. How does this affect your returns?
You might think that your European investment is now dependent on how the rand performs against the dollar and the strength of the euro. But this usually isn’t the case.
How can you measure the currency risk with more than two currencies?
What is important it how the rand performs against the euro. The performance of the dollar doesn’t really matter.
This is because there’s a relationship between the three exchange rates: The EUR/ZAR, the USD/ZAR and the USD/EUR.
When one of the exchange rates changes, you must change one or both of the others in a way that keeps the relationship consistent, Cris Sholto Heaton in Money Week
It all comes down the highly liquid and efficient trading on the foreign exchange market.
The only time when this doesn’t hold true is if the fund you invest in is hedging the currency. This is something to remember if you buy into a hedged currency fund.
When weighing up currency risk of your offshore investments, apart from hedged currency funds, you only need to take into account the rand’s move against your investment’s home currency.
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