Investing in currency can allow investors easier access to overseas markets and other economies, in turn providing a means for better portfolio diversification, according to a foreign exchange expert.
"Investing in foreign currencies can enhance the diversification of an investor's portfolio because it gives them the ability to tap into other markets without having to go to offshore sharemarkets," GFT director of currency research Kathy Lien told InvestorDaily.
However, investors need to be mindful of the correlation between currency movements and sharemarket movements when looking to gain the best diversification benefits.
"It is very often you see the yen move alongside the Nikkei, the pound move alongside the FTSE, the Aussie dollar move alongside the ASX and the same thing with euro dollars," Lien said.
Investors also need to take into account the correlation some currencies have with other currencies, but Lien said this awareness can be developed through common sense.
"You can overcome this if you just apply a little bit of rational thought to it. For example, I think a lot of Australians know that New Zealand is heavily reliant on Australia, so it would make sense that New Zealand's economy and currency is very sensitive to Australia's economy," she said.
"Although some times it's a little bit more obscure, such as Switzerland being very much correlated to the eurozone, it still makes some sense. Canada is very correlated to the US seeing that they send 80 per cent of their exports there. So the geographic distance can help in determining the relationship these countries' currencies have with each other," Lien said.
In gauging how currencies will move the best indicator is interest rates, she said.
"Money shifts from one part of the world to another based not only upon the currency yield, but also upon where interest rates are headed. So if an investor wants to speculate on a currency, they've just got to put some thought into where the interest rates of that country are headed."
