The Currency Game

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 Zealand dollar 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.

What investors should realise is that interest rates are higher in New Zealand than in virtually all developed countries.  It follows then, that a similar investment for example a secured debenture with a finance company specialising in property lending with a similar level of risk, will offer a lower interest rate than what is available in New Zealand.

As New Zealand investors seem to have a great appetite for such investments, we are now seeing offerors effectively offering two versions of the same investment, one in New Zealand dollars and the other in Australian dollars.  Sometimes there are significant interest rate differences between the two.  In other cases, the interest rates will be the same as the offeror is already lending a significant amount on Australian properties at New Zealand interest rate levels. 

Some investors may be tempted to play the currency game.  By doing that, they sacrifice some interest investment return, and are gambling that the New Zealand dollar will fall so they make a capital gain on the currency.  With international investments now falling under the FDR regime changes in the value of the investment because of currency gains are now effectively going to be taxed.

A more logical and lower risk way of effectively playing the currency game, may be to invest in the fully hedged New Zealand dollar version.  The issuer (finance company) makes use of the foreign currency contracts to enhance the investment return significantly.  For example a one year investment in Australian dollars at 7.50%, becomes 8.75% in New Zealand dollars, with no currency risk to the investor.

To provide the same gross return, if you were to invest in the Australian dollar version, the New Zealand dollar needs to fall by over 10% against the Australian dollar over the one year term.   That would mean that the currency would need to fall from the current level of around 89 cents to 80 cents. As always, professional advice should be sought prior to making any investments.  Articles are general in nature and cannot be deemed “advice”.

With prospects of further interest rate rises, and the likely short term consequence of a higher New Zealand dollar, those investors who are playing the currency game on their own, may well find that they would be significantly better off by playing safe and using a fully hedged fixed interest investment.

One thing that is for sure is that it is notoriously difficult to predict currency changes with any degree of accuracy.  Traditionally the most reliable means was to decide if the currency is at or below long term averages and what are the respective interest rates prevailing in the various countries.  It may be that the relative values of various currencies are out of alignment.  When that happens currency forecasts, make weather forecasts look great.