What is forex or FX?
It stands for “foreign exchange” and refers to when you exchange one currency for another, for example, buying some Thai baht with Malaysian ringgit before you travel.
I didn’t even know foreign exchange risk is a thing I even need to consider! How do I know if this involves my investments?
Investing is a longer term game than travelling. When you have a global portfolio you exchange your ringgit into other currencies. The exchange rate between RM and, say, the USD will change over time resulting in changes to the price/cost of your investments.
So, do I take currency risks when I invest overseas?
Yes but…
1. Growth overtakes FX risks
When a business owner wants to expand overseas, she doesn’t worry too much about where currency exchange rates between her home country and the intended country will go. She is just thinking about growth potential and how much profits she will make from that expansion.
Does Muji which sells in Malaysia, Thailand, Singapore on top of their own country in Japan bear extreme FX risks? Does Apple or Samsung? No: they just have a growth strategy. I like it when Uniqlo’s price tag displays prices in a few currencies which incidentally, come up to the same price after conversion to any currency. This is part of Uniqlo’s pricing strategy which is part of their overall long term strategy.
It’s simple economics: the returns on investment must be big enough to dwarf the losses that might come from foreign exchange activity. Governments might also have a policy where if the home currency is weak, their businesses will be able to sell more because the goods and services become relatively cheap as a result of that cheap exchange rate.
Read also: How do I know when to start investing?
2. Companies hedge their FX risks
When businesses are big enough to have a global presence, they will employ very clever treasury people to manage and minimise their foreign exchange risks. This involves deals with banks to fix FX rates at which they buy their foreign currency requirements. Having a globally diversified portfolio combines the collectively treasury smarts of all the hundreds or thousands of companies within the portfolio.
Global companies are also naturally hedged when they diversify into different countries. This means that different currencies that go up and down will offset each other in the countries that the global company buys from or sells to.
So do we still need to personally manage our own FX risks in a diversified portfolio of companies? To put it simply, no.
3. In case of dual-listing: prices will adjust
Some companies are listed in a few stock exchanges. For example, Xiaomi is listed in Hong Kong and Mexico, among other places. The shares are respectively quoted in Hong Kong Dollar and Mexican Peso — is there a price difference when converted to one currency? No, because there are many smart investors who will try to profit from it by buying in the lower-priced market and selling in the higher-priced one.
Similarly, Malaysia’s own listed Top Glove has applied to list in Hong Kong. The same company listed in different stock markets in different currencies will end up with the same value. The company’s share prices are adjusting to its “true value”. In a globally diversified portfolio of stocks, prices of different companies in different currencies will adjust to their true values. These are derived from overall corporate strategies which dwarf the value of foreign exchange gains/losses.
Another way to understand this is…
4. You’re already used to imported consumption
What you buy could also be exposed to FX risks. If you earn in ringgit and you’re buying non-local products at a mall or online, or pick up ramen from Japan at the supermarket, it means a lot of your consumption is imported. Why is it that you don’t really hedge your FX risks for the things you buy? The answer is that you are hoping that your personal strategy through career and investment growth will outpace any FX risks. If your consumption is global and from different currencies, why shouldn’t your investments be?
If your consumption is global and from different currencies, why shouldn’t your investment be?
5. Diversification: left with growth at the end of it
Diversification will grow your equity investment which will offset much of the FX risks. The global economic system will break down if the FX risks were too crippling. It’s riskier investing in only one currency since your consumption is global.
