Afrinvest Talks: An Investor’s Guide to Dollar Denominated Assets
One thing that all investors have in common is getting good value for their money, both in terms of interest income and capital appreciation. Investors seeking to hedge their savings against currency risk in Nigeria mostly look towards the “greenback” as a viable option.
If you have considered investing in dollars, then you must have come across the term “Dollar-denominated assets.” What are they and how do they work?
These questions and more formed the basis of our conversation on the #AfrinvestTalks series titled, “An Investor’s Guide to Dollar Denominated Assets”. Investment Analyst at Afrinvest, Titilayo Ola, was our guest for the day and she helped demystify the concept of investing in dollar assets.
Here is a recap of the conversation.
What exactly are dollar-denominated assets?
Unsurprisingly, a lot of us are interested in knowing more about Dollar-denominated assets and how to build a portfolio with this class of assets. Who does not love to earn in dollars, right?
First, a denomination is a classification for the stated or face value of financial instruments such as currency notes, coins, as well as bonds and other fixed-income investments. So, a dollar-denomination implies that the value of the instrument/asset class being invested in is in US dollars.
A dollar-denominated asset or investment simply refers to an asset that has an underlying value in dollar terms. Investors invest and earn returns in dollars.
Typically, investors outside the United States opt for this class of investment due to the strength of the dollar currency and as a way of hedging against exchange rate volatility. We will talk more about this later.
How does one go about classifying these kinds of investments?
There are various classes of dollar-denominated securities/investments, such as Sovereign Eurobonds, Corporate Eurobonds, Money Market Instruments, Stocks, among others. Eurobonds are a common example of dollar-denominated assets.
Let us look at what these are.
Eurobond refers to a bond issued in international currencies (ignore the word — Euro, these bonds are named after the currency they are traded in). Let us break this into — Euro (as I said earlier, this could be any foreign currency) and — Bonds.
So, what are bonds?
A bond is an agreement between two parties. For instance, Mr A borrows amount X from Mrs B and agrees to pay back an interest rate over a specific period. So, in this agreement, Mr A uses the money borrowed for obligations and to meet his needs while Mrs B parts away with her money for a while intending to earn an agreed interest. Win-Win right?
This is an important way the Government raises money, by borrowing money (in Naira) from investors and paying back interests (in Naira) on these instruments over a period. This is how the Federal Government Bonds work. The Government can also issue Eurobonds — A bond that is denominated in dollars — to allow foreign investors to access them also. This way, the Government borrows in dollars and pays back interests in dollars as well.
Eurobond issuances are not just limited to the Government. Remember I mentioned Corporate Eurobonds? Companies issue them too, to raise capital in dollars and meet their dollar obligations. However, due to the capital requirements of Eurobonds, mutual funds such as Eurobond Funds are available to retail clients in Nigeria.
A mutual fund is a type of investment made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets. Mutual funds are run by professional fund managers, who distribute the fund’s assets and try to produce capital gains or income for the fund’s investors.
Asset Managers offer mutual Funds to enable different investors to pool together funds and invest in Eurobonds. This way, more investors have access to it, as it is bought in units with affordable minimum capital requirements.
Another popular class is investing in stocks publicly listed on the floor of the US stock exchanges such as S&P and Nasdaq. Investors buy units of shares of a company listed, say, Amazon for $1 per share. Unlike bonds that have a fixed rate of return, the stock market is considered very volatile and is dependent on a lot of factors.
If Amazon makes a lot of profit from its E-Commerce business and more investors decide to buy-in, the price of the stock could rise to $1.20, making the investor (who bought $1) 20 cents richer. Conversely, sales could drop due to unforeseen circumstances, such as the COVID-19 pandemic, leading to investors selling off, and price dipping to $0.70. We have seen share prices decline like this in recent times. Of course, in this scenario, the investor has lost 30 cents on every unit of Amazon stock owned.
Although no one has a crystal ball to the performance of stocks, it is advisable to consult your broker and discuss your investment motives and horizon for recommendations and professional guidance.
Benefits of having dollar investments in your portfolio
There are a couple of advantages. I will broadly classify into two: The return which could be coupon payment or interest earned on the investment and the added return because of changes in the value of the naira against the dollar.
For instance, If Mr A had invested N360,000 in a Eurobond with an annual return of 6% per annum last month, the Naira would have been converted to a dollar (say, at N360-$1). This means Mr A invested $1,000 in Eurobond, right? With a 6% return per annum. But last week, The Central Bank announced an “adjustment” to the naira ($380-$1). This means that the naira has lost about 6% of its value. The $1,000 Mr A invested at 6% return per year would yield a return of $60, and at the end of the investment, the total value will be $1,000 invested plus $60 earned which is $1,060.
If tomorrow, Mr B decides to invest the same amount in this same instrument, and the value reduces due to the movement in the exchange rate (N380-$1), N360,000 will only buy $947 worth of investment. This is N360,000 converted to Naira using the official conversion of N380-$1. Mr B’s total return, therefore, becomes 6% of $947, which is $56.82. Upon maturity, the total value will be $947 invested plus $56.82 earned which is $1003.82. Now let us convert both to Naira, using the new official rate of N380-$1. Mr. A got $1,060 (N402,800) while Mr. B got $1,003 (N381,140). This explains capital appreciation and hedging against exchange rate movements.
Asides the capital appreciation and hedge, coupon (interest payment) on Eurobonds are made twice a year — every six months — with the nominal amount (originally invested) paid back upon maturity. Returns could also be more attractive than domiciliary account interest rate which is usually less than 2% per annum. For investments in stocks, capital appreciation (favourable movements in share price) and dividend payments (Distribution of profits by a company to its shareholders) are advantages.
Should you have only dollar-denominated assets in your portfolio?
I will recommend Portfolio Diversification i.e. having different asset classes. This is especially important in asset allocation. It is advisable to combine a variety of assets to reduce the overall risk of the portfolio. Although investing all available funds in dollar-denominated assets appears to look like the best option currently, it is important to note that various asset classes react differently to economic happenings.
Liquidity must be considered as well. Remember your short-term financial obligations, how do you intend to meet them? Eurobonds investments are long-term, stock market players are also recommended having a medium to long term horizon as well.
It is best to access your overall investment goal before making the decision. What are your financial goals? How long are you willing to invest? What are your short-term obligations? Are you risk opposed?
Things to consider when deciding on foreign assets vs. Nigerian assets
One’s investment goal must be considered. For individuals with dollar obligations, investing in dollar-denominated assets is not just safe but incredibly wise. However, even without dollar obligations, distributing a part of your portfolio to dollar-denominated investments is crucial.
A key consideration here will be capital requirements. Here, investors consider the minimum value that can be invested. A unit of euro bond mutual fund typically ranges between $500 — $1,000. The type of investment and tenor (duration) of the instrument also must be considered. Like I earlier said, Eurobonds are considered long-term (Over a year) and charges on early redemption might apply.
Investors are recommended critically accessing terms and conditions before making this decision.
Myth Busters: Common misconceptions about dollar-denominated assets
“You need a lot of money to invest in dollar-denominated instruments”. This is wrong. Investors can sign up and invest in the US stock market at about $100. Also, units of mutual Funds range between $500-$1,000.
“It’s hard to get started with dollar-denominated assets.” You can show your interest and sign up by contacting a local broker. Brokerage firms like Afrinvest do not require you to visit physical offices to sign-up.
“All investment classes are overly risky.” While asset classes such as stocks are considered volatile, fixed income instruments such as Euro bonds offer a fixed return over time.
A final one I would touch on is this “You have to be an expert before you commence”. While we encourage investors to fully understand the investment as well as make well-guided investment decisions, it is important to note that every pro was once a beginner. You can only learn and get better at investing if you begin!
Talk to a broker ASAP!
#AfrinvestTalks is an interactive twitter chat that focuses on breaking down complex investment concepts with the goal of developing a community of avid investors. Follow Afrinvest on Twitter to join the conversation.