Currency risk

Currency risk is the potential for your investments to lose value due to changes in foreign exchange rates. Imagine you invest in a US stock that goes up by 20% in dollars, but during the same period, the Nigerian Naira strengthens by 30% against the US Dollar. In this scenario, although your investment has grown in dollar terms, the appreciation of the Naira means you end up with less Naira than you started with. This is because the value of your investment, when converted back to Naira, decreases due to the stronger Naira. Conversely, if the Naira weakens, your investment in foreign currency could yield higher returns when converted back to Naira.

Let's look at another example. Suppose you buy a bond issued by a Nigerian company that pays interest in US Dollars. If the Naira weakens against the Dollar, the Naira value of your interest payments increases. However, if you’re investing in local stocks listed on the Nigerian Exchange (NGX), this risk is less of a concern because both your investment returns and the currency in which you hold them are in Naira.

Currency risk can also affect dividends from foreign investments. If you own shares in a foreign company that pays dividends in US Dollars, and the Naira depreciates, the Naira value of your dividend payments will increase. However, you might also face a 10% withholding tax (WHT) on these dividends. This means that even if the Naira weakens, the effective amount you receive in Naira could be reduced by the WHT.

When it comes to capital gains, Nigerian investors are subject to a 10% Capital Gains Tax (CGT) on profits from selling investments. If you sell a foreign asset and the Naira depreciates, the profit in Naira terms will be higher, but you will still pay CGT on the total gain. Therefore, understanding currency movements is crucial for managing the overall impact on your investment returns.

Why it matters: Currency risk can significantly affect your investment returns, especially if you hold investments in foreign currencies or markets. Being aware of this risk helps you make informed decisions and better manage your investment portfolio. For instance, if you are planning to invest in foreign assets, understanding how currency fluctuations might impact your returns in Naira terms can help you decide whether to hedge against currency risk or not. Keeping abreast of the Central Bank of Nigeria's (CBN) Monetary Policy Rate (MPR) and its impact on the Naira can also provide insights into potential currency movements.