The Role of Currency in International Investments

Tab 1

September 05, 2014


Investing globally may help diversify your portfolio because it can potentially increase your returns or reduce risk — or both.

 

“The main potential advantage to investing globally is getting exposure to different economies, which often are not in sync with one another,” says Roosevelt Bowman, Senior Fixed Income Analyst for U.S. Bank Wealth Management. “Whether you buy stocks, bonds or other assets, you may be able to ease the risk of a weak economy by spreading those investments globally.”

 

Of course, investing outside the U.S. adds a layer of complexity to the decision-making process. “When investing internationally, you’re making two decisions: first, whether the investment has potential, and second, expectations as to how the underlying currency in that country will fare in the future in relation to the dollar,” says John De Clue, Chief Investment Officer for The Private Client Reserve.

 

Both factors can shift the value proposition of an investment up or down. Understanding currency movements may help inform your investment decisions. Keep in mind that international investing involves special risks such as foreign taxation, currency risks, risks associated with possible differences in financial standards, and other risks associated with future political and economic developments.

Tab 2

September 05, 2014


Making Informed Decisions Related to International Investments

If a foreign currency increases in value against the U.S. dollar, a U.S. investor who owns stock in a company based in that foreign country may see a profit via appreciation of that currency, even before considering what the stock has done. The converse is also true. A decrease in a foreign currency value may have a negative impact for investors of stock in that country’s companies.

 

Remember that equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

 

When considering investing overseas, start by looking at recent economic performance for a particular country and predictions for that country’s market. “Focus on the interest rate outlook,” says Bowman. “If interest rates trend upward, they may contribute to currency appreciation.”

 

Another factor to consider is the balance of trade. If a country exports more than it imports, it may positively impact currency valuation — and vice versa.

“If the economic data is robust, and trends suggest the trade surplus will continue, those can be promising signs,” Bowman says. “We prefer a currency with a trade surplus.”

 

If the conversion aspect of foreign investing seems too complicated, investors may consider purchasing American Depositary Receipts (ADRs). ADRs are stocks denominated in dollars and traded on a U.S. exchange, but they represent shares in a foreign corporation. ADR stocks may reduce administration costs and allow investors to realize capital gains in U.S. dollars. However, keep in mind that these stocks are impacted by currency movement in the same way that a foreign stock trading on a non-U.S. exchange are, De Clue says.

 

What Currency Movements Might Mean 

 

The Allure of Emerging Market Debt

For investors concerned with currency volatility, developed market currencies, such as the euro, British pound or Japanese yen may be a lower-volatility choice. “These currencies historically have changed in value relative to the U.S. dollar, somewhat slowly and over a longer period of time,” De Clue says.

Tab 3

September 05, 2014


In contrast, emerging market economies can be more volatile, although that doesn’t necessarily make these economies less attractive, says Jennifer Vail, Head of Fixed Income Research for U.S. Bank Wealth Management. Many emerging market countries are trying to grow their economies, which means they’re issuing corporate and sovereign debt. “The growth of the emerging market debt space has been substantial in the last decade,” Vail says. “That can be potentially attractive from a value standpoint.”

 

Remember that investing in emerging markets may involve greater risks than investing in moredeveloped countries. In addition, concentrationof investments in a single region may result in greater volatility. Fixed income securities (debt securities) are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramificationsand other factors. Investments in debt securities typically decrease in value when interest rates rise.

This risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Still, emerging market debt is far more liquid than it used to be, and the currencieshave been healthier. Despite these factors, emerging debt continues to provide relatively higher yields. “Most emerging market indices pay yields around 5 percent,” Vail says.

 

To potentially maximize emerging market bond investments, investors should assess whether they can and should invest in dollar-denominated debt or local currency-denominated debt. “The general rule is stay in U.S. dollars when the dollar is strong; if the dollar is weak, consider the local currency,” Vail says.

 

Before making any global investment decision, speak with your Portfolio Manager. “It’s our job to monitor currency movement so we can advise our clients on where we believe the dollar is going,” Vail says.

 

Please see important information below.

Categories:
Investments