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Emerging markets, inflation and currency risk
A post at Interactive Investor Blog on the nominal good performance of Zimbabwe’s stock exchange, is a useful reminder of the importance of real returns. This works both ways, and is why equity investors should not worry too much about currency risk.
You can have situations, as in Zimbabwe where high returns (as judged by an index measured in a currency that is rapidly losing its value) can in fact be misleading.
On the other hand, the fact that shares are investments in real businesses means that foreign investors should not bother too much about currency risk.
When a currency depreciates, this is usually reflected in higher inflation. The more a country trade relative to the size of its economy the faster depreciation will lead to inflation.
Inflation means higher nominal profits (and revenues), which means higher share prices, which should offset the effect of the depreciating currency.
This should be fairly basic stuff, but I have known institutional investors who should know better to worry about it. Don’t. There are plenty of more significant risks to worry about.
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