Risk: Foreign Currency Effects on Foreign Investments Return
Below is my StashAway investment return on Friday, 23rd July 2021 denominated in US Dollars (USD).
Total Investments (USD): $218.20
Total Returns (USD) : -$2.61
Current Value (USD) : $215.59
As shown above, I’m currently making a loss of -$2.61 🙁 but what about my returns denominated in Malaysian Ringgit (MYR)?
Total Investments (MYR): RM901.00
Total Returns (MYR) : RM10.19
Current Value (MYR) : RM911.19
Based on local currency, my unrealized profit is RM10.19 🙂 but in USD, I’m losing -$2.61 🙁 . One investment but two different returns quoted in different currencies. Confused how this is possible? Well, it is due to currency exchange (FX). I’ll explain further in the next section.
Currency Exchange (FX)
Below is a screenshot of the USD to MYR currency exchange chart for the past year, dated 26th July 2021.
I have highlighted 3 sections and they are:
1. FX rate on 26th July 2021 (highlighted in blue)
2. FX rate on 23rd July 2021 (highlighted in red)
3. High and Low FX rates of one year range from 26th July 2020 to 26th July 2021 (highlighted in orange)
From the section highlighted in blue, we can see that:
- On 26th July 2021, 1 USD is equivalent to 4.22665 MYR.
- If I were to convert 1 USD to MYR then I will be receiving RM4.23 (1 USD * 4.22665).
- To truly understand this, think of it in terms of purchasing power.
- With 1 USD, we can buy items worth RM4.23 in Malaysia.
The same applies if we were to convert MYR to USD. To purchase items worth 1 USD, we will need RM4.23. From this simple illustration, we can easily conclude that MYR is inferior to USD but there are pros and cons to this when it comes to foreign investments.
From the previous section, my StashAway returns denominated in USD were $215.59. Now let’s see what the returns might be in MYR for all three highlighted sections.
Blue Highlight (26th July 2021)
Returns in MYR = $215.59 * 4.22665 = RM911.22
Red Highlight (23rd July 2021)
Returns in MYR = $215.59 * 4.2262 = RM911.12
Orange Highlight (High and Low FX rate of one year range from 26th July 2020 to 26th July 2021)
High Returns in MYR = $215.59 * 4.26266 = RM918.99
High Profit/Loss in MYR = RM918.99 – RM 901.00 = RM17.99 🙂
Low Returns in MYR = $215.59 * 4.00647 = RM863.75
Low Profit/Loss in MYR = RM863.75 – RM 901.00 = -RM37.25 🙁
We can observe that the MYR returns from the Blue and Red Highlights are close to my actual MYR returns RM911.19 but the returns from the Orange Highlights (High and Low) differ significantly.
Remember the returns in USD are constant but the currency exchange (FX) rate fluctuates daily. As shown above, this FX fluctuation plays an important role in determining the outcome of the return of our foreign investments. Simply put, FX fluctuation is a risk that can play in or against our favor.
Ideal Foreign Investment Scenario
Ideally, when it comes to investing in foreign markets, the best scenario will be:
1. Stronger MYR against foreign currency on investment date.
Ex: You want to invest $1,000 in the US market. Say on 1st Jan 2021, the FX rate is 1 USD = 4 MYR. This means you need RM4,000 (RM4 * 1,000) to convert it to $1,000.
If the FX rate is 1 USD = 5 MYR, then you will need RM5,000 (extra RM1,000) to have the $1,000.
In this example, you will always prefer the FX rate of 1 USD = 4 MYR as it costs cheaper to purchase USD.
2. Foreign market performs well.
Ex: US market rose by 20%. The initial $1,000 investment is now valued at $1,200. A profit of $200.
3. Weaker MYR on-selling date.
Ex: 1 USD = 4.5 MYR. Converting $1,200 to 4.5 MYR, we get a return of RM5,400. A profit of RM1,400 (RM5,400 – RM4,000) 🙂 .
In point 1, the exchange rate was 1 USD = 4MYR.
In point 3, 1 USD = 4.5 MYR meaning we get an extra 0.5 MYR for the same amount of 1 USD.
Investing in foreign markets the currency movement will increase/decrease the return on the asset itself
Worst Case Scenario
1. Weaker MYR against foreign currency on investment date.
Ex: 1 USD = 5 MYR. We require RM5,000 to invest $1,000.
2. Foreign market performs poorly.
Ex: US market decline by 20%. The initial $1,000 investment is now valued at $800 only. A loss of $200.
3. Stronger MYR on-selling date.
Ex: 1 USD = 4.5 MYR. Converting $800 to 4.5 MYR, we get a return of RM3,600. A loss of RM1,400 (RM5,000 – RM3,600) 🙁 .
In point 1, the exchange rate was 1 USD = 5MYR.
In point 3, 1 USD = 4.5 MYR meaning we get less 0.5 MYR for the same amount of 1 USD.
Real Case Scenario
My StashAway investment returns as I shared at the beginning of this post are a perfect example of a real case scenario. The returns in USD were negative, but the FX rate from USD to MYR was in my favor (MYR weaker/depreciate against USD).
Market and FX rate movements are truly out of our control. They can move up, down, or remain sideways. All we can do as an investor is to be aware of the risks we are taking when it comes to foreign investments. In a way, you may treat the fluctuation of FX as a form of diversification.
Whenever MYR is weaker, foreign investments return tend to perform better and when MYR is stronger, the return can be slightly poor. But local investments quoted in MYR tend to perform better when MYR is stronger/appreciate against USD. Therefore, it is advisable to invest in both local and foreign markets and not to depend solely on a single market.
To explain this point, I’ll share a snippet from the book Naked Money by Charles Wheelan. It’s a real case scenario on how the currency exchange rates can affect international businesses and why it’s best to invest in both local and foreign markets.
If you would like to check how the currency exchange rates may have impacted your unit trust investments, you can always look them up from the fund’s interim or annual report under the “Statement of Income and Expenditure” section. Below is a sample.
As highlighted in red above, this fund PGSF gained RM556,000 from foreign exchange in 2020 but lost RM1,663,000 in 2021. Having said that, the total income in 2021 was double compared to 2020. We can conclude the fund performed well in 2021 but not necessarily the FX rate. This is another example to illustrate how the fluctuation of the FX rate can impact foreign investments returns.
A part-time Malaysian blogger writing his thoughts online. Interest in both personal finance and economics, mainly the behavior aspect of them. I consider myself Poyo since I do not have any significant credentials in both fields, so readers beware. Thanks for reading.