Mark Hewlett wishes everyone would leave Europe alone. The managing partner with London-based Anello Asset Management is frustrated by all the attention his part of the world is getting when the “big elephant” is really America, its massive deficit and its depreciating dollar. “That’s what everyone’s most scared of,” he says. As a currency expert, he’s carefully watching what’s happening in the United States—if confidence is further damaged, the greenback’s status as a global reserve currency may be in peril.
It’s unlikely that will occur soon but, long term, many asset managers think that an emerging-market currency, likely the Chinese renminbi, will become the global reserve currency of choice. If that happens, demand for the yuan (as it’s also known) will explode, and its price will rise accordingly. But even if investors still cling to the greenback for safety, as they did in 2011, several emerging-market currencies should still see their values increase. And that’s good news for retail investors who are looking for other ways to grow their portfolios.
Currencies can help investors in two significant ways: they offer a yield and the prospect of appreciation. For the former, investors can get a return by simply changing Canadian dollars into a currency that has a higher interest rate. If, for example, you put loonies in an Australian savings account—the country’s central bank rate is 4.5%, 350 basis points higher than Canada’s—the yield could be as high as 6%. Even easier, an investor can open a foreign-exchange account at an online brokerage and buy currency there. Brokerages, says Hewlett, will pay the central bank rate minus a few bucks for fees.
When it comes to appreciation, investors should treat currency like they do stocks. Find the undervalued buys that have long-term growth potential. François Bourdon, associate chief investment officer with Montreal-based Fiera Sceptre, says that while there are other dynamics that determine the price of a currency, it ultimately comes down to supply and demand. Just look at the renminbi. Despite the Chinese government’s efforts to keep it from appreciating, increasing demand has boosted its value 30% versus the U.S. dollar over the past six years. Bourdon thinks it’s still undervalued by 30%. He predicts that the price will increase by about 3% every year for the next five to 10 years. “China’s not even the most attractive currency,” he adds.
The most appealing currencies are in Asia. That’s because of the region’s high GDP growth, its robust exports and the low cost to produce materials. Bourdon explains that as long as Asian nations keep exporting goods, demand for their currencies will rise. Exporters, he explains, are paid in U.S. dollars. They then exchange the dollar for their domestic currency. The more American dollars get changed into local currency, the more demand there is for those homegrown shekels. Demand can come from within the country, too. As the Asian middle class grows and seeks higher wages and higher-end items, more pressure will be put on a currency’s supply-and-demand balance.
Many investors consider currency more volatile than other securities, but that’s not true, says Hewlett. In fact, it’s far less jumpy than commodities or stocks. Year-to-date, the S&P/TSX composite index is down 13%; the loonie’s fallen 3% since Jan. 4. Forex gets its risky rep because most currency traders use large amounts of leverage in order to get higher returns. Retail investors should avoid leverage.
Currency is also more liquid than most asset classes. Monica Fan, head of business development with London-based Millennium Global Investments, says that more than $4 trillion of U.S. currency is traded every day. While the idea is to hang on to an undervalued currency for the long term, it’s easy to exit if you need to. “That’s very helpful in a period like we’re in now when people want exit positions available,” she says.
Hewlett points out that currency should be considered a separate asset class to stocks and bonds. It’s a useful diversification tool, especially if your portfolio is heavily weighted to the domestic market. How much to allocate to this asset class depends on your risk tolerance and the weight of your other foreign holdings; between 5% and 10% is enough to give your portfolio a boost.
When deciding what currencies to buy, look at macroeconomics and fundamental valuations, says Jeff Zhang, chief investment officer with San Francisco–based Mellon Capital Management. If a country is unstable, it’s likely its currency will be too. Many African countries share similar characteristics to Asian nations—they export, the cost of living is low—but political instability makes investing there too risky. Look at a country’s historical inflation, Zhang advises; the lower, the better.
Zhang also keeps watch of a country’s current account deficit, the total imports of goods and services versus total exports. The more exports, the better. “A country like Argentina is running a huge deficit,” he says. “The currency will depreciate.”
Look for countries with high interest rates. Then, even if the money doesn’t appreciate, the interest will provide some return. Bourdon says the Malaysian ringgit is a good buy; not only is it undervalued by 40%, but its deposit rate is 3%. Canadian investors can open a Malay bank account online, though it may be easier to hold the currency in a forex account at a discount brokerage.
There are several ways to invest in currency. Besides opening a bank account or holding money in a forex account, some people buy stocks in another denomination. However, you’re then subject to market risk as well as currency risk. If you like all your holdings in one place—such as a bank brokerage account—consider buying currency ETFs. These funds hold either actual units of currency or short-term debt. It’s an easy way to make a pure play on foreign exchange. Most of the major currencies can be bought with an ETF, such as the Australian dollar (NYSE Arca: FXA), the Indian rupee (NYSE Arca: ICN) and the Chinese yuan (NYSE Arca: CYB). Some of the less popular currencies such as the ringgit don’t have an ETF, so you’ll have to buy them in a forex account.
Because the currency market is so massive and it’s not as familiar to investors as other asset classes, Hewlett warns against getting carried away. Treat currency like any other investment. “If you think a currency will go up, stop thinking about forex accounts and currency forwards and just buy that currency,” he says. “Don’t be too clever.”
Undervalued currencies may not come a dime a dozen anymore, but there’s still plenty to choose from. Ways to play them include opening a foreign bank account (all these countries except China have deposit insurance), holding them in a forex account with a Canadian brokerage, buying currency ETFs or buying foreign stocks on their home-country stock markets.
Malaysia’s money tops François Bourdon’s list of must-have currencies. The Montreal-based asset manager says that the country is moving up the manufacturing chain. It has commodities including oil and natural gas, and the cost of living is cheap. As the country’s manufacturing sector grows, so will the ringgit. He says it’s about 40% undervalued.
Singapore’s big attraction is that it’s the main shipping destination in Asia. When global commerce improves, the number of shipments—and therefore dollars—into the country will increase. “Everything goes through Singapore,” says Bourdon, who likes the country’s export potential and its respect for the rule of law. The city-state’s dollar is undervalued by 20%, he says.
Indonesian exports are booming—global demand for the nation’s goods increased 37.5% in the first nine months of 2011 compared to a year earlier—and Bourdon thinks its share of the Asian export market will increase. The currency has appreciated nearly 30% against the U.S dollar in the past three years. Bourdon thinks it could rise by 25% more.
The renminbi is a no-brainer buy, says currency expert Mark Hewlett. With China poised to become the world’s largest economy by the end of the decade, its GDP growing four to five times faster than developed markets, and a huge trade surplus, its currency can only rise. Keep in mind the yuan has only limited convertability. While the Chinese government will likely float it one day, it could take years. That’s a good thing, Hewlett says. Its value will climb slowly but steadily.
The Australian dollar is about 15% overvalued, says Bourdon, but with the central bank’s “cash rate” at 4.5% and strong demand for commodities, some experts maintain their view that it’s a good purchase. Hewlett likes it because it’s liquid, its central bank is strong and its fundamentals look better than the American dollar’s. “Most people sell Australian dollars,” he says. “I say, Why not buy?”