What history tells us about which currencies to invest in today

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How do you know whether your rand-based South African investments are performing as well as they would have had you invested in another currency or territory? What measure represents a true picture of investing in the rand against, say, the British pound? While investors might look at growth in one country as attractive, especially over time, they often miss key variables that can skew the true picture.

Shortly after winning the Nobel Prize for Economics in 1974, Friedrich Hayek announced “… we have to explain how prices operate as signals, telling people what they ought to do in particular circumstances”. The implications of his comment provide a valuable lesson when we consider how prices and values have changed since that time. In fact, it’s a lesson that needs to be taken into account when attempting to measure investment performance. This is especially so in a globalised investment landscape, where, when assessing or forecasting performance, economic signals need to be benchmarked beyond countries in isolation.

What seems like impressive growth in one part of the world may pale when compared to another, or when compared to the value of another currency. Over time, outcomes can look very different when you compare key factors such as inflation and exchange rates on currency volatility.

A Forty-year Story

Let’s explore an example from a South African perspective with 1974 as the starting date.. We will use the value of local property as an indicator of how investing in one currency (in this case, the South African rand) performs in relation to another (the British pound) over a period of forty years, and provide a more objective view of the effects of currency exchange and inflation.

In 1974 the average house price in South Africa was ZAR21,261. At the time, the rand was strong against sterling, with every pound worth 1.61 rand. Those 1974 South African house prices, converted into pounds, give us £13,205 – a favourable comparison at the time.

In 2014 South Africa, the price of an average South African house had risen an impressive 59 times to ZAR1,275,530 (GBP75,031).

Add Exchange Rates for Clarity

But how impressive is the selling price of ZAR1,275,530 when benchmarked against a foreign currency?  Over a forty-year period, SA:UK exchange rates changed dramatically, with the rand against the pound sliding from 1.61 in 1974 to an average of 17 in 2014 – and continuing to slide in 2015. This means that in 2014 the average South African house price, quantified in pounds, was only £75,031 – reducing that seemingly impressive multiple from 59 to 5.4.

Inflation Makes Things Clearer Still

To arrive at a more complete picture of the 2014 figure converted to pounds, we need to consider inflation..  In South Africa over this period inflation grew 4188 per cent against 955 per cent in the UK. So, if you examine the figure of £75,031, and take into account the rate of inflation in the UK, the figure in 2014 would be £142,717 (ZAR2,426,189).  This tells us that average house prices in South Africa have lagged by around half the rate of inflation in the UK, despite growing above the rate of South African inflation.

As an alternative point of reference, had you placed your ZAR21,261 in a South African rand inflation bearing account, by the end of 2014 you would have ZAR911,769 – which means South African house prices have beaten inflation locally, albeit only by a multiple of 1.4.

Although the increase in price looks attractive when viewed only in the context of South African values, internationally, a similar investment would have done much better had it been made in sterling. Compare, for instance, the investment made in sterling in a UK house over the same forty-year period, as seen in the graphs below.

What’s the Message for Investors?

In short, when looked at in equal terms, G3 currencies of Euro, Dollar and Sterling offer safer returns from the point of view of both currency and inflation volatility. This, even before you consider how an individual asset might perform in a particular market, or over a given time horizon.

Does all this mean you should only invest in the UK? Or that you should only buy property in the UK? Not at all. What is clear, though, is that when optimising an investment portfolio, wherever in the world you live, history demonstrates that choosing to invest in a G3 currency is more likely to provide growth and stability over time..

Of course, offshore investment comes with a number of variables and every investor should take expert advice when considering both strategy and tactics. Whichever way you choose to go, make sure you view any investment through an international lens. Look at what effect often-missed factors such as inflation and foreign exchange could have on growth and you’ll have a much clearer picture of how to judge past, present and future performance.