Sun | Nov 29, 2020

Oran Hall | Protecting investment assets against a depreciating currency

Published:Sunday | October 25, 2020 | 12:16 AM


The Bank of Jamaica, BOJ, recently issued another of its US dollar-denominated indexed notes, an interesting financial asset that protects investors against depreciation of the value of the Jamaican currency without the need to invest US dollars.

Although the indexed notes were made directly available to commercial banks and primary dealers, other investors were able to access them through the primary dealers.

Investors in the indexed notes paid for them in Jamaican dollars, which were converted notionally to US dollars at the 10-day moving average buying exchange rate applicable on October 12. Interest and principal, when it matures, are to be paid in Jamaican currency at the Bank of Jamaica 10-day moving average buying rate applicable on the day of payment. This provides some protection to investors if the Jamaican dollar loses value against the US dollar.

This latest issue is due to mature in 2023. Interest is to be paid quarterly, but considering that the minimum sum that could have been invested in the instrument was the Jamaican dollar equivalent of US$10, 000, this is not an instrument that small investors could access.

Investing in foreign currency-indexed notes or bonds seems the most obvious way to hedge against the risk of the Jamaican dollar losing value without investing directly in instruments denominated in a foreign currency.

There is, however, at least one other means available to investors to earn more in Jamaican dollars when the local currency loses value without investing in US dollars or other foreign currencies: investing in companies that earn meaningfully from the export of goods or services. The income they earn in foreign currency increases in Jamaican dollar terms when the value of the JMD depreciates.

As this boosts the profit of such companies, it enhances the chances of the stock price appreciating for those that are listed on the market. This avenue is accessible to small investors as investing in the local stock market does not require a substantial outlay of funds.

Investors may opt to invest in foreign currency through the USD Market of the Jamaica Stock Exchange. Or they may utilise the platforms, which some investment houses have available, to buy and sell securities in foreign markets. Investors desiring to use this approach need to decide how best to do their research so that they can make informed and effective decisions. Beyond buying stocks and bonds, they can also invest in mutual funds.

The explosion of our unit trust market and the birth of one local mutual fund with six investment funds, five of which are global investment funds, meaning they invest in foreign currency-denominated securities, has given investors many options to invest in foreign currency-denominated instruments indirectly by buying units in the foreign currency funds of the unit trusts and shares in the mutual fund.

Some of these foreign currency funds invest primarily in equities and some in both equities and fixed-income securities, but most invest in fixed income securities. This means that there is not as much scope for capital appreciation as there is for income, and this suggests that the level of risk is not as significant considering that fixed income securities tend to be safer than equities in a general sense.

But it should not be forgotten that some fixed-income securities can be quite risky. Professional fund managers would be expected to do a proper evaluation of the instruments before committing to investing in them.

The access to securities denominated in or indexed to foreign currencies creates opportunities for portfolio diversification. As we have already observed, investing in more than one currency has the potential to protect the value of a portfolio when the local currency loses its value.

Additionally, there is scope to invest in more than one market, also spreading risk. Further, to the extent that fund managers select equity securities well, investors can benefit from funds being invested across several industries and several countries.

While it is true that instruments like the BOJ US Dollar-Indexed Notes are generally out of the reach of small investors, they need not feel left out of the market for instruments that offer some protection against the national currency losing its value. They can get that protection and at the same time build a diversified investment portfolio by investing in unit trust and mutual fund portfolios that invest in foreign currency-denominated securities and foreign financial markets.

Oran A. Hall, principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.