How currency reduces portfolio risk as a diversifier
Loading player...
From the Hungarian forint to the Chilean peso, currencies can be a valuable partner in managing investments.
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 “drugs and oil” portfolio will earn in dollars as the global default currency.
As with other asset classes, combining noncorrelated 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.
Currencies can also be a source of return in at least two ways:
Buying a currency when it is attractively priced and selling when it appreciates, for example the inexpensive and appealing Canadian dollar, or Loonie.Owning a currency that is structurally sturdy and likely to strengthen steadily for long periods. You can buy it and hold it forever (Warren Buffett’s favourite holding period).
The Swiss franc or Swissie, is a good example, given Switzerland’s 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 while lowering risk.
Currencies can also be a source of risk, with dangerous implications for returns. Rushing from one currency into another that is strong in a moment of weakness often produces painful results, certainly in the near term. Selling the rand at R19 to buy the greenback in April produced a three-month loss of 10% — and slightly more if we consider dollar balances earned 0% interest vs the opportunity cost of interest earnings on rand investments.
Venezuelan heap
In five or 10 years, this rand recovery might be seen as a mere blip if the rand were to reach R30 or R50 to the dollar should the rand buckle under the weight of SA’s crumpling economy. Or it could be that, in fashion with its multidecade habit, the rand will recover 30%, 40% or 50%, as after the Rubicon speech, global financial crisis and Nenegate.
The rand could also collapse in a Venezuelan heap in which that currency has undergone a cumulative devaluation of 100-million to one since 2008 — an investment of $1m in 2008 would be worth 1c in 2020. Zimbabweans know the devastation of currency collapse ...
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 “drugs and oil” portfolio will earn in dollars as the global default currency.
As with other asset classes, combining noncorrelated 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.
Currencies can also be a source of return in at least two ways:
Buying a currency when it is attractively priced and selling when it appreciates, for example the inexpensive and appealing Canadian dollar, or Loonie.Owning a currency that is structurally sturdy and likely to strengthen steadily for long periods. You can buy it and hold it forever (Warren Buffett’s favourite holding period).
The Swiss franc or Swissie, is a good example, given Switzerland’s 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 while lowering risk.
Currencies can also be a source of risk, with dangerous implications for returns. Rushing from one currency into another that is strong in a moment of weakness often produces painful results, certainly in the near term. Selling the rand at R19 to buy the greenback in April produced a three-month loss of 10% — and slightly more if we consider dollar balances earned 0% interest vs the opportunity cost of interest earnings on rand investments.
Venezuelan heap
In five or 10 years, this rand recovery might be seen as a mere blip if the rand were to reach R30 or R50 to the dollar should the rand buckle under the weight of SA’s crumpling economy. Or it could be that, in fashion with its multidecade habit, the rand will recover 30%, 40% or 50%, as after the Rubicon speech, global financial crisis and Nenegate.
The rand could also collapse in a Venezuelan heap in which that currency has undergone a cumulative devaluation of 100-million to one since 2008 — an investment of $1m in 2008 would be worth 1c in 2020. Zimbabweans know the devastation of currency collapse ...
