When investing money overseas, one of the most common concerns for South African investors is the Rand/Dollar exchange rate. Many believe the exchange rate is crucial in determining the optimal time to invest in foreign markets. However, while the Rand’s value against the Dollar is undeniably significant, it might not be the most critical determinant in achieving successful investment returns. In this blog, we will explore the importance of the exchange rate and shed light on other vital factors that should be considered while investing overseas.
The Impact of Exchange Rates on Offshore Transactions
Transaction volumes decline substantially when the Rand experiences a sharp drop against the Dollar. This reaction is natural since investors fear losing value when converting their Rands to foreign currencies during times of Rand weakness. The Rand’s value psychologically influences investment decisions, leading investors to hold back on offshore opportunities when the Rand is underperforming.
Rand’s Depreciation over Time
Over the years, the Rand has consistently depreciated against major foreign currencies, including the US Dollar. The Rand has depreciated by approximately 6% per year over an average five-year period. That means it is realistic to expect the Rand will continue to depreciate by 6% per year, although it will not happen in a smooth, predictable pattern. While this trend suggests that holding offshore investments can be beneficial in the long run, it is essential to recognise that currency fluctuations can impact investment returns in the short term.
The Correlation of the Rand with Global Sentiment
Another crucial point is the relationship between the Rand’s value and global market sentiment. The Rand tends to strengthen during periods of positive global sentiment, leading to potential losses in offshore investments despite rising markets. This phenomenon occurs because the appreciation of the Rand counteracts the gains made in foreign assets, resulting in lower overall returns.
The Key Factor: What You Do with the Money
Amidst all the discussion about the Rand/Dollar exchange rate, investors often overlook the most crucial factor: what they intend to do with the money they invest overseas. The significance of the exchange rate largely depends on the nature of the offshore investments.
Investing in Shares and Bonds
For those investing in foreign property, shares and bonds, the primary focus should be on the valuation of those assets rather than the exchange rate. Shares, bonds and property are subject to market dynamics, business performance, and global economic conditions. Their inherent value can overshadow the impact of currency fluctuations over time. It is more important to buy these assets when they are cheap or fair value. The exchange rate should be less of a concern as the starting valuation of your investment assets will significantly impact your growth over time.
Investing in Cash Overseas
Conversely, the exchange rate becomes a critical factor if the intention is to invest in cash or cash-equivalent assets overseas. Currency fluctuations can significantly affect the returns earned on these assets because your interest on offshore cash tends to be relatively low. In this scenario, timing the investment with favourable exchange rates becomes more crucial.
The Phasing Approach
Instead of attempting to time the exchange rate, a more practical strategy is to consider phasing out your money in batches over time. Investing smaller portions of your assets at regular intervals can mitigate the risks associated with volatile exchange rates. For instance, investing every three months or annually, depending on the size of assets, can help average out the impact of currency fluctuations.
Using Local Rand-Hedge Unit Trusts
Another valuable tool to hedge against Rand volatility is by utilising local rand-hedge unit trusts. These funds invest in companies with significant offshore revenue streams, providing a natural hedge against Rand depreciation. Using a rand-hedge unit trust with a monthly debit order, you can gradually build up your offshore investment and periodically send out lump sums, taking advantage of potentially favourable exchange rates.
While the Rand/Dollar exchange rate is important for investing overseas, it should not be the sole factor driving investment decisions. The nature of your offshore investments should guide your approach, with a focus on asset valuation rather than solely on currency fluctuations. By adopting a phased investment approach and utilising rand-hedge unit trusts, investors can navigate the complexities of the foreign exchange market more prudently and enhance their chances of long-term investment success.
Written by Warren Ingram
CFP®, Wealth Manager, public speaker and author. Host of the HonestMoney podcast. FPI South Africa Financial Planner of the Year 2011.