Currency forecasting not for the faint-hearted
Retail investors often view cash as a safe haven, yet the fact is that cash in overseas markets can prove unexpectedly volatile. With incredibly low interest rates in developed markets, local investors invested in offshore cash are mainly exposed to the f
Felix Ubogu, Head of Asset Consulting at Liberty Corporate, says that domestic investment instruments have two sources of return – income and capital appreciation; whilst in a global situation, there is a third layer of (potential) alpha, namely the currency movement.
“There tends to be broadly two types of investors who opt to invest in global cash. Firstly, the average risk-averse retail investor with a basic appreciation of cash as a conservative asset class. In this instance, the risk is that they believe investing in offshore cash provides the same defensive qualities as local cash and is a safer way to gain the offshore exposure that they keep hearing so much about.”
Ubogu notes that these risk-averse investors, who appreciate the merits of offshore investing as a diversification strategy, mistakenly believe that the risks they face in specific asset classes are the same in across different markets. “With global cash, investors face the prospects of low yields, no capital appreciation and are mainly exposure to currency fluctuations, which can be difficult to accurately predict in the short-term and which is often as (if not more) volatile than local equities.”
He says the second type of investor is the more sophisticated retail or institutional investor. These investors often use investments in global cash as a bet on certain currencies. “Sophisticated investors make an active decision with an appreciation for the risk-return dynamics involved. This may involve looking at the purchasing power parity (PPP), an economic theory that aims to determine the relative value of currencies by assuming that the same goods and service should have the same price in different markets.”
Ubogu says the reality is that it is extremely challenging to accurately forecast the direction of any currency in the short term, but in the case of the Rand it becomes even more difficult to do so as it is often used as a proxy for other African currencies, making it even more volatile.”
“Almost anything can drive the movement of the Rand. If investors become increasingly bearish on emerging markets – not just South Africa – then the Rand can suffer in sympathy as it is one of the more liquid currencies for people to trade. This was evidenced at the time of the Arab Spring almost two years ago when the Rand was hit by the wave of demonstrations and protests.”
Ubogu notes that while economic theories that aim to determine currency movements may work in the long term, in the short term there are too many variables that can play a role in driving currency movements to make actual forecasts accurate. “Over the medium to long term, one would expect the Rand to depreciate against the US dollar. However, there can be significant deviations from PPP in the short term.”
“There is no tried and tested economic theory of how a currency should perform in the short-term – with economic and financial drivers, political changes and social developments all sometimes playing a role in how it moves – but for the average retail investor who believes that all Cash is a safe asset class, they should bear in mind that this is possibly the case only for domestic cash. However, with inflation at 5% and interest rates in the same region, domestic cash offers little/no real return. As such, domestic cash is also arguably not a safe haven at all when it comes to protecting one purchasing power” concludes Ubogu.
