But as global trade has become the norm, even the returns on our domestic stocks and funds have become heavily influenced by the movement of the pound against foreign currencies.
The bulk of FTSE 100 earnings are now derived from overseas, and many of our portfolios now contain stocks whose earnings are denominated in dollars, euros, yuan, yen or rupees. Choosing to ignore the risks of currency when investing should be done at your own peril.
Currency may not always present a risk, though, and can sometimes work in your favour. Anyone who held UK-denominated investments ahead of the Brexit vote will have benefitted from the fall of the pound against the dollar. That’s because when the increase in earnings is translated from the dollar back into pounds, the dollar’s strength means that you get more pounds for your money.
What is important is that, when you look at your portfolio as a whole, you understand the risks that you face if the pound moves significantly against another currency, and are prepared for them.
Here are some of the places where you may have currency risk, and how you can reduce it if you feel you need to.
Investing in funds can be a great way to increase the diversity of your portfolio, and that diversity can be very global.
However, many funds have investments overseas, and this means that your investment has an added layer of risk on it. If the fund you are invested in holds assets in a currency that weakens against the pound, the amount of money you get will be less, even if the assets increase in value in their home currency.
Some popular unit trusts and OEICs (open ended investment companies) offer both hedged, and non-hedged versions of funds that have investments overseas.
With these types of fund, you can choose whether or not to expose yourself to currency fluctuations on top of the usual ups and downs in the price of funds. The difference in the return you get can be dramatic. For example, if you had bought the JP Morgan Global Equity Fund at the beginning of 2016, you would have found your investment had increased in value by 25.31 per cent by the end of the year. However, if you’d bought the hedged share class, which aims to remove the currency risk from the fund, the same investment would have only been 7.47 per cent up by the end of 2016.
In this case, because of the pound’s weakness in 2016, hedging your portfolio would work against you. However, this is not always the case, particularly at times when the pound has been strong.
For example, if you had bought the Invesco Balanced-Risk fund and held it for the calendar year 2015, you would have lost 4.2 per cent if you’d opted for the sterling hedged version, and 9.9 per cent on the standard version.
Looking for a hedged fund is one way to reduce currency risk, but do check whether it costs more to hedge, and if so whether you feel the cost is worth it.
Exchange traded funds (ETFs) can be a great way to get low cost global exposure. These funds can be set up to track an index or commodity cheaply and effectively, so that you can get exposure to the performance of a foreign stock exchange without the complication of buying foreign shares or actual bars of gold.
However, their ease and global reach means that many people find it hard to understand the currency risks they are taking on.
To find out what currency risk you have in your portfolio, you need to know the underlying currencies of the ETFs within it. The underlying currencies are the currencies in which the assets are valued in. This can have a huge effect on your profits, even without you realising it.
For example, if you use an exchange traded product to invest in gold, the product is always valued in US dollars, so you are also taking a bet on the value of the dollar. Which is fine when the dollar does well, but not when it doesn’t.
In many cases you can buy hedged versions of these funds, which strip out this risk. ETF Securities Ltd, for example, offers both hedged and unhedged versions of its Gold ETFs. As an example of the effect on performance, the hedged version returned 29.5 per cent last year, against 28.2 for the non-hedged version. However, in 2015 it lost 8.4 per cent, against 7.8 per cent for the non-hedged version.
Again, hedging does cost money, so if you buy hedged investments you may find you are exposed to higher direct and indirect costs.
Instead of using hedged funds, many people simply diversify their portfolios as a whole to try to balance currency risk. So, for example, if you felt your investments were too exposed to the strength of the euro against the pound, you could put a portion of your investments into a currency tracker that balanced out your risks, using an exchange traded product. Alternatively, you could manage your risk by ensuring you bought a larger number of stocks that have many of their earnings in the Eurozone, or a fund that concentrates on this area.
However you choose to mitigate currency risk, the important thing is to revisit your portfolio often. In the current period of volatility, your hedging strategies will need to change over time, and if there are large currency swings you may need to rebalance your portfolio. Make sure you consider currencies every time you look at your investments as a whole.
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Selftrade does not provide investment advice. This article is the authors view and is not the view or opinion of Selftrade and Selftrade accepts no liability for any loss caused as a result of the use of this information. The opinions expressed are those of the author at the time of writing and should not be interpreted as investment advice.
The value of investments can fall as well as rise and any income from them is not guaranteed and you may get back less than you invested. Past performance is not a guide to future performance. We do not provide advice or make recommendations about investments. If you have any doubts about the suitability of an investment, you should seek advice from a suitably qualified professional adviser.