{"id":428860,"date":"2020-08-29T15:00:00","date_gmt":"2020-08-29T13:00:00","guid":{"rendered":"https:\/\/businesstech.co.za\/news\/?p=428860"},"modified":"2020-08-28T14:10:38","modified_gmt":"2020-08-28T12:10:38","slug":"using-currency-to-reduce-risk-and-boost-returns","status":"publish","type":"post","link":"https:\/\/businesstech.co.za\/news\/business\/428860\/using-currency-to-reduce-risk-and-boost-returns\/","title":{"rendered":"Using currency to reduce risk and boost returns"},"content":{"rendered":"

From the Hungarian forint to the Chilean peso, currencies can be a valuable partner in managing investments, writes Dr Adrian Saville, chief executive, and Kyle Ferreira, investment analyst at Cannon Asset Managers.<\/p>\n

\n

Currencies offer a source of diversification. The oil-heavy Norwegian krone, for instance, behaves differently to the industry-based Swiss franc; and they each behave differently to the US dollar. When things are tough in energy-based Norway, things could be fine in pharmaceutical-exporting Switzerland; and your \u201cdrugs and oil\u201d portfolio will earn in dollars as the global default currency.<\/p>\n

As with other asset classes, combining non-correlated assets into a portfolio creates diversification which means you can achieve the same investment outcome with lower volatility. In this way, currency, as a diversifier, reduces portfolio risk.<\/p>\n

Currencies can also be a source of return in at least two ways. Either by buying a currency when it is attractively priced and selling when it appreciates \u2013 for example the currently inexpensive and appealing Canadian dollar, or Loonie.<\/p>\n

Or returns can come though owning a currency that is structurally sturdy and likely to strengthen steadily over long stretches of time, meaning you can buy it and hold it forever (Buffett\u2019s favourite holding period).<\/p>\n

The Swiss franc, or Swissie, is a good example, given Switzerland\u2019s geopolitical advantages, and its strong economic and financial systems. Thus, adding such currencies to a portfolio could be a good way to add to investment returns whilst lowering risk.<\/p>\n

Currencies can also be a source of risk with dangerous implications for returns. So, rushing from one currency in a moment of weakness into another that is strong often produces painful results, certainly in the near term.<\/p>\n

Selling the rand at R19 to buy the greenback in April 2020 produced a three-month loss of 10% \u2013 and slightly more if we consider dollar balances earned 0% interest versus the opportunity cost of interest earnings on rand investments.<\/p>\n

Of course, in five or ten years\u2019 time this rand recovery might be seen as a mere blip if the rand were to reach R30 or R50 to the dollar, should the ZAR buckle under the weight of South Africa\u2019s crumpling economy.<\/p>\n

Or it could be that, in fashion with its multi-decade habit, the rand will recover 30, 40 or 50 percent as after the Rubicon speech, global financial crisis and Nenegate.<\/p>\n

In a third scenario, the rand could collapse in a Venezuelan heap where that currency has seen a cumulative devaluation of 100,000,000 to one since 2008, meaning an investment of $1 million in 2008 would be worth 1 cent in 2020. Zimbabweans know the devastation of currency collapse (2008), as do Germans (1923) and Brazilians (1985).<\/p>\n

If nothing else, this emphasises that currencies can be volatile. If managed well, volatility can be a blessing; if not, volatility is a source of risk or even destruction. However, simply buying other currencies is not good diversification \u2013 rather, acquiring other currencies at good valuations makes for good diversification.<\/p>\n

This raises at least two questions. In a world rocked by Covid-19 and shrouded in uncertainty, which currencies possess structural strength? And based on this assessment, on what valuations are they currently trading?<\/p>\n

We assess currency stature by using 12 different measures of strength and stability to score all major currencies and many smaller ones across three pillars:<\/p>\n