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Investing Basics: How To Hedge Foreign Currency Risk When Investing In Emerging Markets

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October 26th, 2021 21:24

Hedge foreign currency risk when investing in emerging markets

Around four-fifths of the world’s population lies under emerging markets while being responsible for one-fifth of the world’s economy. Emerging markets always attract international investors as correlations with assets in mature markets are comparatively low. 

Therefore, to hedge foreign currency risk when investing in this scenario needs a lot of strategic planning

With a more stable currency, an investor could feel more in a comfortable zone; however, this could discourage them from foreign currency investments. 

Without a doubt, investing in emerging markets comes with major risks. This comes as a concern for the growth of developing markets as venture capitalists tend to bow down and not go for foreign currency investments. But not taking the benefit of emerging markets just because of risks, is that the right decision?

Foreign currency investments can be advantageous if the correct means and techniques are implemented. 

An investor can hedge foreign currency risk when investing in emerging markets. The question that would arise is how to do it

How to hedge foreign currency risk when investing in emerging markets?

Countries of choice

The first thing to consider to hedge foreign currency risk is the country of your choice

Prioritize the countries and their respective currencies in your list, based on your awareness and knowledge. Ensure to check the rules, the growth of their markets, and any other relevant information that could affect your investment.

Secondly, choose the fields you would want to invest in. Select only those sectors that you are most aware of and would be confident to invest in. This is important to help secure your money.

Timing of investment

Volatility in developing markets can impact your investments in a major way. Devise a plan on how you can stay updated on the news when investing in emerging markets. This can help you time your investment in the market.

Taxation

A type of complication while hedging foreign currency could be taxation. Foreign investors are taxed while trading in various emerging markets. Profits are taxed in these markets and it can bother an investor even more if you will not experience any gain.

It all depends on the chosen foreign market. Check with the broker or company you are dealing with to know more about involved taxes

Diversification

Diversification is always suggested as a method when investing in the foreign currency risk market. However, diversification in foreign currency markets can turn out to be really expensive

The trading volume of emerging market stocks is certainly less compared to developed ones.

Mixing asset classes in appropriate proportions that have low correlation to one another can reduce risk at the portfolio level, in spite of a major volatile market.

Beware of all types of risks

When investing in a foreign market, it is important to be aware of the possible risks that you, as an investor, could face. You can consult a broker in the respective foreign market if needed. Market volatility, on the other hand, is something that no one can control; therefore, it is important to have a backup plan of your finances that is entirely in your hand.

Conclusion

Hedging foreign currency investments in many emerging markets could be a challenge; however, it is not impossible to maintain it.

Foreign investments can surely help in constructing a stable portfolio if you follow the above-mentioned points. Combining domestic and foreign assets together can create better long-term returns and secure your portfolio from volatility and future risks. 

Frequently asked questions

1. How do you hedge currency risk in a portfolio?

  • To hedge out currency risk when buying international shares, you need to sell the currency in which the shares are denominated and buy your domestic currency.

2. How do you hedge long-term currency risk?

  • Companies that have exposure to foreign markets can often hedge their risk with currency swap forward contracts. Many funds and ETFs also hedge currency risk using forward contracts. 

3. What is currency risk hedging?

  • A foreign exchange hedge is a method used by companies to eliminate or hedge their foreign exchange risk resulting from transactions in foreign currencies. This is done using either the cash flow hedge or the fair value method.

4. Should I currency hedge my portfolio?

  • It is generally accepted that in order to maintain international bonds’ defensive characteristics in a portfolio, they should be hedged as their benefits would otherwise be overwhelmed by currency movements.

5. How do you hedge against a market crash?

  • Diversification is one of the most effective ways to hedge a portfolio over the long term. By holding uncorrelated assets as well as stocks in a portfolio, the overall volatility is reduced. Moreover, alternative assets typically lose less value during a bear market. So, a diversified portfolio will suffer lower average losses.




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