Be currency smart

Your South African Rand returns might not be what you think

This is for South Africans or anyone with investments in “soft” currencies.

Many of my South African friends make the mistake of comparing the returns they earn in South Africa, for example, 9% on a fixed deposit or 5% on a JSE Top40 Index Fund, to the returns generated by US Dollar denominated investments, like an S&P 500 Index Fund returning 10%.

To compare apples to apples, you need to also consider the currency devaluation of the South African Rand (ZAR) to the US Dollar (USD). The same would apply, for example, to an investment in Indian Rupee (INR) which has depreciated against the USD over time.

This chart shows how the ZAR has depreciated against the USD over the last 10 years, at an average of 6% per year:

To help explain the concept, here are 3 investment scenarios, all over a 5-year period (link to calculations here):

1. R100,000 invested in a Sygnia JSE Top40 Index Tracker fund, would be worth R156,000 now. That’s an annualized return of 9.3%.

2. R100,000 converted to USD 5 years ago and held in cash ($7’052), would be worth R133,000 now. That’s an annualized return of 6% measured in ZAR terms (assuming ZAR is your reference currency).

3. R100,000 invested in the Sygnia S&P500 ETF would be worth R244,000. In ZAR terms, that’s an annualized return of 19.5%. Of the 19.5% annual growth, 6% is attributable to the currency gains alone (see number 2 above) and 13% is attributable to the S&P500’s returns.

   In this case, it would be a mistake to compare the S&P500’s returns (13%), which is in US Dollar, to the JSE Top40 returns (9%), which is in South African Rand, because you are ignoring the Rand’s devaluation.

Here is an illustration of the three scenarios:

How can you put this knowledge to use?

To compare investment returns in different currencies to allow you to make the best decisions, make sure you consider the currency fluctuation impact over time.

The past performance of the ZAR is not guaranteed to be the same in the future, but using a 10-year average devaluation against the USD is a good rule of thumb. Therefore investing in the JSE Top40, returning 9% on average, while losing 6% of the ZAR’s value against the USD means you are in effect only gaining 3% annually in USD terms. Over 5 years you missed out on almost R90,000 by not investing in the S&P500.

Personally, if an equity investment in ZAR does not return more than 19% per year, I would not consider it a good investment given the risk taken. Although past performance is not an indicator of future performance, my opinion is that in the long term the ZAR’s devaluation against the USD will continue and I am also optimistic about the future performance of the US capital markets.

You need to be sure you’re adequately compensated for the risk you’re taking (the risks being: being exposed to ZAR and equity investments where capital is at risk). The alternative way to look at this would be that 19% is the opportunity cost of not converting your ZAR to USD and investing in a S&P500 ETF.

If you hold cash: Because there is a significant depreciation of the ZAR against USD over time, it’s important to consider its impact on the ZAR you hold in the long term. In USD terms you are losing 6% per year (10-year average) by holding ZAR.

If you want to learn more about investing in an Index Tracker ETF, like an S&P500 Index Tracker, read my blog here and if you’re interested in getting started read my blog: “Investing 101:Getting Started”.

*Calculations used above reference the 5 years annualised performance as per the fund fact sheets on Sygnia’s website, and the 5-year and 10-year US Dollar movements.

Sygnia S&P500 ETF: https://www.sygnia.co.za/fund/sygnia-itrix-sp-500-etf-portfolio

Sygnia JSE Top40: https://www.sygnia.co.za/fund/sygnia-top-40-index-fund

Disclaimer:

This is for informational purposes only and should not be considered personalized investment advice.

Past performance is not an indicator of future performance.