ASK Dr. NOET
Investing for OFWs
By Dr. Johnny Noet Ravalo
INQUIRER.net
First Posted 09:53:00 03/26/2008
(Part 4 of a series)
I just read your article and I am seriously interested in investing in Manila. I am based in Los Angeles now, work in a bank, but funny how little I know where to invest! I would like to ask for some leads. Appreciate your advise – Kristine
As long as Kristine works in the US and wants to invest in Manila, she will have to graduate into a “cross-border cross-currency investor”. This is a world apart from our stereotype view of OFWs who merely remit money to their families.
Cross-currency investing is one of the most difficult challenges in personal finance. Investing forces us to think of guestimated values at specific points in the future. We are vulnerable to all the financial nuances from the perspective of at least two competing currencies. Do I buy a 3-year bond that is denominated in pesos or in US dollars? Or am I better off doing this via third currency (like euros) and then converting the proceeds in the future?
Given the limited information, I will take the conservative route and suggest to Kristine Philippine Government Securities (GS) and Republic of the Philippines (ROPs) paper. GS would be peso-denominated but will offer a better nominal return than US Treasuries. ROPs are still Philippine obligations --- and therefore offer the usual interest rate premium --- but these are typically in US dollars. ROPs provides Kristine the convenience of not having to convert her dollars and yet earn a Philippine interest premium.
This would be Kristine's initiation to Philippine investment opportunities. They are straightforward instruments because they are accessible and easy to track. There are many other instruments out in the market but these would require more monitoring on Kristine’s part.
To pursue the investment, Kristine will have to work out the paperwork with a Philippine-registered broker of your choice. This is not a matter of style. It is the requirement of law under the OTC Guidelines issued by the Philippine SEC. But once these requirements are settled, Kristine should be on her way.
The problem of cross-border, cross currency investing is not confined to OFWs. There are two inter-related problems that must be dealt with: (1) how can I decide on the currency of my investment and (2) when do I convert the proceeds into pesos?
Investing Across Currencies
Forecasting forex rates is often not productive. A number can always be generated but getting it right on a consistent basis is totally different. Fortunately, there is a tool which can at least give us some clue of the possible direction of the movement between two currencies. While this tool is not fool-proof, a structured clue would be better than a wild baseless guess.
The tool is called by different names but I refer to it as the implied forward rate. The basic premise is that a difference in interest rates between two economies will show up as movement in the exchange rate between their two currencies.
What if the current dollar-peso rate was P40 per dollar? You are interested in making an investment in a one-year instrument and you find that the peso-denominated Treasury Bill is at 5.0 percent while a US Treasury Bill was at 2.0 percent.
Many would immediately think that it would be profitable to explore the difference in rates by converting dollars into pesos and then invest the proceeds in the 5.0 percent Philippine T-bill. The strategy looks obvious but it also is shortsighted. Any investment is not measured by what we see today but rather by what we expect to get in the future.
What we know is that if the investor invests $1,000 in the US instrument, it becomes $1,020 in one year (that's $1,000 x 1.02). The question is whether he would have gotten better or worse value if he invested via Philippine pesos. If you are already counting your marbles and say that the investor would have gotten P42,000 ($1,000 x P40 x 5%) after one year, then shouldn't we ask what that would be worth in US dollars by then?
What would P42,000 be worth in US dollars one year from now? Well, that depends on the dollar-peso rate one year from now. If you do a bit of pencil-pushing, some possible answers may be:
If the dollar peso rate is P38, then P42,000 is worth $1,105.26.
If the dollar peso rate is P39, then P42,000 is worth $1,076.92.
If the dollar peso rate is P40, then P42,000 is worth $1,050.00.
If the dollar peso rate is P41, then P42,000 is worth $1,024.39.
If the dollar peso rate is P42, then P42,000 is worth $1,000.00.
The investment will be measured against the dollar-peso rate when the investment matures. The more the peso depreciates from the current exchange rate of P40 per dollar, the less the investment is worth in dollar terms. It works the other way too with the future worth increasing as the peso appreciates against the dollar.
There must be a particular value of the future dollar-peso rate that would make the investment totally neutral between the two currencies involved. That future dollar-peso rate is the implied forward dollar-peso rate and it happens to be P41.1764 per dollar. This rate is directly calculable based on the interest rate differential between the Philippines and the US.
At that conversion rate, P42,000 will be equal to $1,020 so it would not matter (not counting any transaction fees) which of the two currencies the investor chooses in executing the investment.
This simple tool is necessary because it sets a baseline scenario which is useful for choosing the currency denomination of our investment (all other things the same) as well in calculating for a possible hedge (see the following segment to this piece).
Going back to the example, if you happen to believe that the dollar-peso rate one year from now will be weaker than P41.1764 against the dollar, buy the one-year dollar-denominated instrument with a 2.0 percent stated return. If your best guess is that the peso will be stronger than P41.1764 versus the dollar one year hence, Kristine should convert her $1,000 into pesos at the current exchange rate and use the proceeds to buy the one-year peso-denominated instrument at 5.0 percent nominal return.
Everyone will notice that after all the number-crunching we actually still do not have a fool-proof list of cant-miss-investment-leads. Kristine still needs to make her best forecast of the dollar-peso rate one year ahead and make an investment today based on that forecast. It may turn out that her best guess is correct ... or wrong.
Unfortunately, there is no way of getting around that. The “view” on which side of this fence the dollar-peso rate will settle in the future is something that Kristine must generate on her own or with the help of investment professionals.
Happy investing, Kristine.
(Have a question for Dr. Noet? Email personal_finance@inquirer.net.
(Noet Ravalo is a macro-financial economist by practice and profession. He was chief economist of the Bankers Association of the Philippines until 2002 and has since been doing consulting work. Since 1994, he has been asked to provide technical inputs to both the Senate and the House of Representatives on various economic and financial legislation, some of which will have big impact on Filipinos' personal finances.)
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Relates stories:
How currency hedging works (Third of a series)
What kind of investor are you? (Second of a series)
What is the best way to start an investment? (First of a series)
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