Investing in attractive assets denominated in appreciating currencies is a simple concept but can be very complex to execute. Nothing confirms this point more than the recent downgrade of the US’ credit rating from AAA to AA+ by ratings agency Standard and Poor’s (S&P). Intuitively one would expect the US dollar to devalue substantially, but just the opposite happened in the markets. Foreign-exchange traders purchased more US dollars, pushing up its value as demand for Treasuries soared amid concern the global economic recovery was faltering.

This downgrade is actually an opportunistic coincidence, which highlights some key areas of interest in this follow up to the “SSL In the Money” article published on July 13, 2011, entitled “Global Opportunities for Future Growth”. This article will focus on the potential benefits to be gained from investing in assets in other currencies as more and more investors are gravitating to investments not only in US dollars but in other currencies around the world. Indeed, the case for investing in currencies is three-fold: It provides a hedge against the loss of value of the investor’s home currency, it provides the investor with more investment opportunities and it enables further diversification.

Foreign currency investing is like buying the “stock” of a country and one should therefore carefully examine several elements of an economy. In particular, these include growth and inflation. Investors should seek to invest in a growing economy, since this will likely result in greater demand for its currency, and consequently a rise in the currency’s value.

However, at the same time, generally high growth generates inflation. It is important to note that the value of a currency is directly related to its purchasing power. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, an investor’s home currency purchasing power is eroded and a loss of real value occurs. For example if interest rates in a country yield two per cent per annum after tax and the annual rate of inflation is seven per cent, the investor’s purchasing power has effectively declined. However if that same investor invests in another currency which appreciates by over seven per cent against the investor’s home currency, he/she has at least maintained his/her purchasing power. That is the first advantage of investing in other currencies – it is a hedge against the loss of value of the investor’s home currency.

Other factors that investors should consider when evaluating a country’s economy are: geo-political risk (look for economies with stable political environments), diversification (look for economies that are not dependent on one particular good or service but rather diversified across products and across export markets), balance of payments, and other macro-economic indicators.

For example, let us say you noticed that the Canadian dollar is valued more than the US dollar and you expect this trend to continue. Not only is the Canadian economy stable, but it continues to outperform many of its developed nation counterparts, including the US. The economy is diversified, earning from energy, grains, financials and it is also politically stable. On this basis you may decide to gain some exposure to Canada. The next decision is which asset denominated in Canadian dollars you will purchase, whether stocks, bonds, or options.

Let us say you decide to invest in Suncor Inc (TSE:SU) due to its dominant position in Canada’s energy industry. You convert your Jamaican dollars on Dec 31, 2010 to Canadian dollars at a rate of 86.46:1 and purchase SU shares on that same day at C$38.28 each. On May 31, 2011 you decide to sell your SU shares at C$40.45. After you receive the proceeds in Canadian dollars you convert it back to Jamaican dollars at a rate of 88.86:1. You therefore realise a total gross gain of 8.5 per cent, which comprises a capital gross gain of 5.7 per cent from the movement of SU’s share price from C$38.28 to C$40.45 and gross 2.7 per cent from the appreciation of the Canadian dollar against the Jamaican dollar. This demonstrates the other aforementioned benefits of investing in other currencies — the investor was able to gain exposure to another investment (Canada) while diversifying into another sector (energy).

It is however important to note that there are risks involved in investing in other currencies. The most notable of which is currency/exchange rate risk — a form of financial risk that arises from the potential change in the exchange rate of one currency in relation to another. Furthermore, currency markets can be volatile. As such, investors should consider all the dynamic factors that influence different currencies’ values in order to make successful investments, which can be instrumental in maintaining purchasing power, increasing returns and diversifying portfolios.

Deon McLennon is an Equity Trade at Stocks & Securities Ltd. You may contact him at dmclennon@sslinvest.com.