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How To Handle Falling Currencies

The Motley FoolOne of the easiest ways for a company to boost sales is to the cut price of its goods and services. If a business can increase the number of units it sells by more than it loses through the cut in price, then it should rake in more revenues.

Of course, there are other ways to increase turnover. A company could go out and seek new markets or it could even develop new and more innovative products, which could also boost the top line. But those strategies can take time.

Tried and tested

So, cutting prices remains a tried-and-tested method of achieving instant revenue gratification. Hence the successful marketing ploys used by pile-them-high-and-sell-them-cheap merchants and the numerous end-of-whatever sales we often see promoted by shopkeepers.

Just as companies and corporations can boost sales through price cuts, countries can do something similar to boost economic activity. They can devalue their currencies, which is a proxy for cutting prices. By devaluing its currency, a country is effectively providing its domestic companies with an immediate leg-up. It has helped exporters become instantly more competitive, even if those companies have done nothing other than carry on their business as normal.

Currently, there are signs that many countries, if not devaluing their currencies, are intent on holding down the value of their currencies. For instance, the US is continuing to pursue Quantitative Easing, even though its economy is showing obvious signs of growth and employment is rising at a healthy clip. Meanwhile, the European Central Bank has cut the cost of borrowing and New Zealand has held interest rates even though there are indications that its housing market may be overheating. Elsewhere, Japan is driving down its currency to help revive its economy through boosting exports.

A clever ruse

Currency devaluation might, at first sight, seem like a clever ruse. However, it can create unwanted problems for investors, especially those who buy overseas shares. For instance, an investor might be delighted that an investment in a company abroad has appreciated 20%. But the euphoria could quickly turn to disappointment should currency movements move 20% in the opposite direction. In other words, the adverse exchange rate movement could wipe out any capital gains from the shares.

Conversely, a poor investment might even turn into a profitable one, should currency movements move in your favour. So, even if shares in an investment might have done poorly, a favourable exchange rate could turn an unsatisfactory investment into an acceptable one. Of course, the ideal scenario would be a good investment coupled with a favourable exchange-rate movement. That way, you win twice – capital gains on top of currency gains.

Sidestepping currency risk

Unfortunately, it is not easy to sidestep currency risk. Exchange-rate risk may present itself even if you do not invest in overseas shares deliberately. A significant portion of revenues generated by Straits Times Index (SGX: ^STI) companies come from outside of Singapore. What’s more some Singapore blue chips generate negligible income from within the Garden City. Consequently, profits for these companies could fluctuate depending on prevailing exchange rates.

With two variables, namely, currency and company performance to ponder, investing in overseas companies or companies that generate income from abroad might seem to be as difficult as trying to catch a fly with a pair of chopsticks.

Thing is, most of us have no idea what might happen to the greenback, the aussie, the kiwi, the loonie or the rupee against the Singapore dollar. That is a part of investing we have little or no control over. It might be possible to insure against exchange rate movements through foreign currency hedging but that merely adds extra costs to investing, which could reduce your returns. In any case, countries that can adjust currencies downwards can just as easily massage them back up again.

Perhaps one of the best ways to hedge against currency risk is to build a diversified portfolio of shares that themselves have wide geographic interests. A good place to start could be through a low-cost Straits Times Index tracker such as the SPDR STI ETF (SGX: ES3) and Nikko AM Singapore STI ETF (SGX: G3B). That way, you could get exposure to the likes of Thai Beverage (SGX: Y92), which generates almost 90% of its revenues outside of Singapore, and Jardine Cycle & Carriage (SGX: C07) which is heavily exposed to Indonesia.

However, the key question for investors should always be this: Is it better to invest in a business with overseas links which exhibits strong fundamentals but with a risk that the currency might fall or invest in a business with poor fundamental but a chance that the currency may rise? For me, it is always better to try and control something I have control over than to try and control something I can’t. So, focus on companies, not currencies.

A version of this article first appeared in The Independent on Sunday.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.

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