Foreign investors in emerging markets have suffered double whammy this year:
- Local stock market is down
- Falling currency
Let’s just focus on Indonesia and Malaysia markets. For first 9 months of 2015, IDR has depreciated ~17% against USD, while MYR has depreciated ~26% against USD. That’s huge!
Imagine that you invested your USD in Malaysia stock market and got 20% return in 9 months. Instead of celebrating for the good return, you are actually net down nearly 6% because of FX impact (the exact number should not use subtraction between local currency return and fx move; I just simplify it quick illustration). Forex risk is real and if you don’t manage it, then it will manage you.
I saw several funds that invested in Malaysia and Indonesia stock market. Their YTD returns ex-FX have been respectable given the turbulence in the region and globally this year. However, they are badly hurt by the depreciating IDR and MYR, bringing net performance to a loss.
I experienced this myself. My pain:
- On 17 Dec 2008, I bought at USD 19.69 with exchange rate USD-SGD 1.46265.
- On 1 Aug 2013, I sold at USD 75.85 with exchange rate USD-SGD 1.2741.
- The return in USD was 285.2%, but the return in SGD currency was 235.5%. So, FX loss took away nearly 50%.
- On 20 Feb 2009, I bought at USD 14.45 with exchange rate USD-SGD 1.5407.
- On 1 Aug 2011, I sold at USD 39.99 with exchange rate USD-SGD 1.1982.
- The return in USD was 176.7%, but the return in SGD currency was 115.2%. So, FX loss took away nearly 61%.
- The bigger mistake was selling Torchmark. Big mistake. That’s for another post next time.
There are several other US stocks that I bought during GFC. They turned out ok, but FX took away some good percentage points.
My sister was asking me to invest in Indonesia property. I thought for some time and didn’t do it in the end. She went ahead. My concern was the depreciating IDR as I earned SGD. In the long run, IDR has been depreciating every year. It stabilized at SGD-IDR 7000 for some time in 2011 and I thought that stability could last longer. Then, hell broke loose. Now, it’s at SGD-IDR 10287. That’s 47% loss!
Back to investing. As fund manager, it’s really very tough to manage the performance to take into account the FX impact. Analyzing companies and monitoring their developments are tough and time consuming enough. That can consume most of the time already, if not all the time. Analyzing FX move is entirely different skill set.
Analyzing FX can involve studying the account surplus/deficit, export/import, monitoring macro economy, fund flow, etc. Basically, there are many moving variables and it’s very hard to quantify the impact of each variable. Plus, it involves behavior of the market in which a turbulent market will see fund outflow from emerging market while a strong economy see more fund inflow. Some banks have FX specialists, giving their view and forecast, but I’m not sure the consistency at which they make their prediction.
When I was back in hedge fund, we did short AUD and it’s profitable trade. Whenever my fund manager asked my view about AUD, I would say down, but when the next question is how much, I could never answer. There were some months that AUD bounced up and I couldn’t explain why either. All I knew was that commodity was facing and continue to face downcycle till now and near future. AUD got stronger during the boom, and when it’s over, so should the strong AUD. AUD has fallen from 0.95 in 2013 to 1.41 now.
The point is, when you invest in foreign market, you must be very aware that FX impact can be substantial. Ultimately, the net return is not measured in local currency, but in your fund currency. If your overseas investment got 30% in 2 years but FX impact was -25%, there is little to celebrate with net return of less than 5%.
In emerging markets, FX is hardly stable. That’s just part of the game. Even developed market can see large currency fluctuation during bad time. In short term, currencies can fluctuate wildly. In long term, some currencies can fluctuate less wildly and may form a long term depreciation of, say 5%, every year against USD. That should certainly be included in overall valuation and discount before you make the investment decision.
Again, forecasting FX move is very tough, very speculative, and in most cases, beyond investors’ skill set (it’s certainly beyond my skill set). If you want to make a rough estimate, then see how it behaves in the past 5 years, 10 years, and 15 years. That should cover several economic cycle. See how much it has depreciated throughout the time. That’s rough estimate how much it will depreciate in future.
Forecasting future based on historical result is speculative. I agree. Economic situation can never be the same between two different time. However, if you don’t have skill to analyze FX move, then you should better give yourselves some larger margin of error by assuming the fx depreciation will continue to be that bad, if not worse.
If you do have skill to analyze it or form a reasonable judgment based on experience and sound analysis, then it’s a different story. However, note that analyzing FX itself can be time consuming and can take away substantial amount of time you spend on analyzing companies and following their development. Therefore, when you invest in foreign market, you should expect higher return in local return to compensate the potential loss in FX. If you see that the foreign currency is structurally getting stronger, then it’s an added bonus for investing in that market.
What’s my view on some currencies? As I mention several times above, I don’t have this skill set. However, just my general view on these currencies in long term:
- CNY should get gradually stronger. That’s been the case for years. China is running on account surplus and possesses lots of foreign reserves. The economy is growing at 6-7% per year, albeit slowing, still better than many developed markets. It still has large room to improve its currency gradually for next few years.
- MYR should get back stronger than current level. I guess next year, but you should never trust me on that. The current 1MDB issue certainly causes several percentage loss in its currency. It’s hard to quantify. But I think MYR is oversold at this level.
- IDR. Hmm… This is my own country, so maybe I’m biased. I was expecting the economy to do better along the time. Indeed, 5% GDP growth is reasonably good for this country. When it’s at USD-IDR 12000, I thought it couldn’t get worse after 20% fall. And now it’s 14691. Against CNY, it fell from 1361 in 2011 to 2314. You can see how tough it is for those Indonesia business importing goods from China. My friends’ business got impacted a lot. It’s just so disappointing how the Indonesia government run and manage IDR. I guess, once the general market pessimism is over and the current government starts spending more, its economy will bounce back and so will the currency.
- SGD. Seems to me that current level is quite fair. USD is getting stronger due to its recovering economy. But I think the recent strength is ahead of its interest rate rise. I believe the interest rate rise will be small and gradual. If not because of recent global market sell off, the Fed could have raised the rate.
I started investing more in US market this year as I think that USD will get stronger. Luckily USD did get stronger. But at current FX rate of 1.42 for USD-SGD, I don’t have a clear view. Investing is like following a story board. As the story unfolds, we’ll make adjustment along the way. So, do remember to follow the story.