Currency – Is it a Real Issue for Fixed Interest?

Currency is just one of the many risks many investors take on.   We need to be aware of the actual investment risks involved.  As the New Zealanddollar has increased in value relative to some currencies, a number of people have been asking if there are any fixed interest investments available in other currencies, especially in Australian dollars. After all, Australian cash rates are somewhat higher than New Zealand’s.

What investors need to realise is that interest rates worldwide are at close to all time lows. This is a lingering by-product of the economic crisis, when Reserve Banks around the world slashed their cash rates as part of a financial stimulus package. Forecasting how long interest rates will remain low is not a science. It is more akin to taking an educated guess. It is notoriously difficult to predict currency changes with any degree of accuracy. 

Relative currency levels and interest rates vary from country to country. A country with a favourable economic outlook is likely to have a currency that appreciates. An example of this is the New Zealanddollar’s appreciation against the United Statesdollar. Using the pricing of a Big Mac, it seems that the New Zealanddollar is still undervalued against the United Statesdollar. This is probably better news for lovers of big Macs, rather than New Zealandexporters of goods priced in US dollars.

It was only a matter of a few years ago, that the reason given for the New Zealanddollar being high was because our interest rates were high. Clearly that is not now the case, although the New Zealanddollar is currently slightly below its long term average versus the Australian dollar.

There are very good fixed interest opportunities overseas. Currency volatility can be a real issue though, as our currency can vary in value by a greater extent than what the coupon (interest) rate is. This is the very reason why it is normal practice for overseas fixed interest investments to be fully hedged against the New Zealanddollar. The practicality of this for retail investors is such that they would usually need to invest via a managed fund to do so. There is also the impact of taxation, whereby the foreign investment taxation rules will invariably apply.  

International fixed interest funds have been rather “me too”. They have traditionally been handicapped by high fee structures. New Zealandofferors have put a margin on, over and above that of the overseas fund manager. Often the end result was that the return to the investor was lower than what could be achieved in a bank deposit. A known return from the bank was a better prospect than the additional diversification that an international fixed interest fund offered.

Basically, currency hedging can be used to widen the universe of fixed interest investment opportunities for New Zealandbased investors. However the reality is that it really needs to be done within a managed funds type of environment, as the costs for a small investor would probably be prohibitive.

Another factor to consider is that as interest rates rise, bonds when valued at market prices will invariably lose capital value. Managing the investment duration to minimise the effects of fluctuating yields and capital values of fixed interest investments is also usually something that is seldom achievable by individual investors.