By Jeremy Gaunt, European Investment Correspondent
LONDON, Oct 21 (Reuters) - The passive devaluation of the U.S. dollar and the potential for emerging market currency appreciation are changing the playing field for investors seeking to tap into Asian and Latin American growth.
To date, the "currency war" has done little to cool investors' ardour for emerging markets. Such plays, indeed, helped drive world stocks to more than two year highs last week.
But shifts in currency rates, epitomised by the dollar's recent four-month fall of more than 15 percent against major currencies <.DXY>, can impact everything from product demand and costs to borrowing to the repatriation of profits.
So the potential for a new currency landscape is set to make life more complicated for investors, particularly those seeking to buy large developed-market multinational equities with solid exposure as proxies for emerging markets.
There will be an array of positive and negative factors to balance.
Consider, for example, the impact of a strengthening yuan on U.S. and European companies plans to make direct investments or joint ventures in China. If Washington gets its way and persuades Beijing to revalue, China will get more expensive.
This would mean additional costs to companies whose plans have not yet been implemented. But the flip side for investors is that companies with an existing presence would have a competitive edge.
"Anyone who wants to invest in China after a revaluation has taken place has to pay more in his own currency to do that," said Karl Sauvant, executive director of the Vale Columbia Centre on Sustainable Investment, in New York.
"That is why those who are there (already) would have an advantage."
Sauvant reckons the prospects for currency appreciation in emerging markets may prompt companies with investment plans to bring them forward -- another bottom-line cost implication for equity investors to grapple with.
HIGHER RETURNS
In theory, a developed-market company with high exposure to emerging markets should benefit from depreciation of its home currency in two ways -- because their goods are cheaper and because the new exchange rate boosts their foreign profits.
But this tends to reflect an old model of business for many companies as it assumes they produce goods at home and then export them.
Many large companies now produce their goods in situ.
Volkswagen
For companies with manufacturing presences in countries with appreciating currencies, the exchange rate effect will be muted. They may even find that the deflationary impact of a higher rate will weaken the very domestic demand that they are there to exploit in the first place.
Ranged against that, however, would be reduced costs for raw materials such as oil in emerging market plants because these are for the most part priced in dollars.
And then there is the windfall of profits reported back to investors at home, converted by a favourable exchange rate.
"If emerging market currencies appreciate significantly, then the portion of earnings increases," said Tristan Hanson, strategist at Jersey-based wealth manager Ashburton.
Looking at VW again, imagine what a 10 percent appreciation of the yuan against the euro would do to the 395 million euros of operating profit the firm got from China joint ventures in 2009.
That profit, incidentally, was 20 percent of Volkswagen group's total operating profit for the year -- underlining the exposure such firms can have.
WHAT NOW?
It is not, of course, as clear cut as just assuming that an appreciation of a currency makes a multinational richer.
Many have large hedges on currencies in order to take away the volatility on foreign exchanges. Emerging market profits are also often ploughed directly back into the countries from whence they derive.
Investors are also divided over whether it is still a good play to buy export-oriented developed market stocks to get proxy emerging market exposure or to go for the real thing.
Ashburton's Hanson, for example, suggested that volatility in emerging markets might prompt more investor interest in proxies. But Credit Suisse veteran investment analyst Bob Parker of Credit Suisse told a conference this week that such proxies were now looking expensive.
There is little doubt that even with currency tensions and potentially major foreign exchange moves emerging markets will remain attractive to global investors and that proxies will be a part of it. But they may have to be more selective.
"Given that we seem to be moving through a volatile period, one would want to make sure (a) company is managing its risks," said Neil Dwane, chief European investment officer of fund managers RCM. "It is going to be quite complicated." (Additional reporting by Michel Rose and Maria Sheahan, editing by Mike Peacock)