This week I want to dedicate my blog to the currency of living
abroad.
How many people do you know in your home town or in your home country
that worry about currency fluctuations? Have you ever heard anyone worry
about the EUR v GBP or EUR v USD level at any one time? Maybe they look once a
year when they are going on holiday and leave the post office with a smile on
their face or have a sullen expression depending on the exchange rate. But for
the rest of the year?
It's not so simple for the life of the straniera/o!
Almost everyone I know is concerned to some extent about the exchange
rate. Whether it is someone who is building a house and watches the
exchange rate drop (you know who you are!) or people living on fixed
pension incomes. I also include myself in the exchange rate trap since part of
my earnings are in GBP. I understand your pain.
Of course, these are the simple aspects of currency re/devaluation and
to some extent we can budget and plan for its eventuality and prepare
ourselves. But what about when multiple currencies are at play in our
investment portfolios. There it can create even more unusual effects.
The following comments (slightly modified by myself for easier
understanding) come from Robert Walker at Rathbones Asset managers who wrote a
piece about the interplay of currencies in a managed portfolio of assets. I
thought it might interest you
CURRENCIES AT WORK
With a portfolio approach that is global in nature, currency volatility
is playing an important role in the reported returns to clients on a
quarter-by-quarter basis. The last two years have seen substantial US dollar,
British Pound and Euro volatility as confidence in the respective economic
regions ebbs and flows. This has a profound effect on how the overseas assets’
performance are reported in the investor’s base currency, based on their
individual circumstances.
US DOLLAR
The US dollar has been a safe haven in times of increased economic uncertainty.
In the first few months of Donald Trump’s presidency, the US dollar
strengthened on the presumption that tax cuts would stimulate the economy. This has subsequently
reversed, as the realisation of many false or premature promises has taken
hold.
BRITISH POUND
The British pound has seen its value fall significantly against the US dollar
and euro due to Brexit uncertainty. Until the exact path of Brexit and the
economic ramifications of this are known, it is likely that the pound will
remain weak. There will be many twists and turns along the way until March
2019, not least with the Conservative’s General Election result and subsequent
reliance on the Democratic Unionist Party. The current status quo is very
vulnerable to further turmoil and the weakness of sterling is a by-product of
this.
EURO
At the turn of 2017, markets were focussing on the possibility of
anti-establishment vote in both The Netherlands and France. At the time, both
countries had parties with anti-European Union policies in opinion poll
ascendency and thus the consensus was to remain underweight in the Eurozone.
Since that time, the euro has undergone a substantial recovery of over 14%
against the US dollar as political risk subsided and economic confidence in the
Eurozone improved. Against sterling, it is up over 7% this year in addition to
the weakness after Brexit of 2016. Both of these currency movements have had
the impact of weakening the value of US and UK assets for euro investors.
THE INTERPLAY OF CURRENCIES
Performance of globally diversified portfolios has been affected by each of
these currency movements. For example, had a US investor bought euro assets at
the start of 2017 the translated value would be increased by 14% due to the
currency effect alone, but a euro investor who bought US assets at the start of
the year would be seeing a translated loss of over 12%. Investors in sterling
will have seen the value of overseas assets increase markedly during the Brexit
process as the pound has weakened significantly, but euro investors with
sterling exposure have seen a corresponding fall.
Over the long-term, we would expect the impact of shorter term currency
movements to average out. For the pound particularly. (See comments about
the Pound in the right hand column).
When managing portfolios in euros, sterling and US dollars, we ordinarily have
a degree of country of residence bias to a client’s base currency. However,
this is dependent on a client’s unique circumstances. Our portfolios are globally diversified, where we
are trying to gain exposure to a portfolio of high-quality global assets in
order to reduce risk to any one particular economic region. Indeed,
currency analysis can be somewhat circular, as the underlying investments in
each region are typically multi-nationals that have a global spread of
currencies. This can mean that an individual portfolio may deviate against a
certain measure or benchmark over the short-term, but which is most likely a
temporary effect, but we feel that the spread of global investments will reward
clients well over time, rather than focusing on fast changing and unpredictable
currency movements.
HEDGING
Almost all investment professionals admit that forecasting future
direction of currencies is a thankless task, as currencies are largely
influenced by future unknown events which are, by definition,
unpredictable.
As with most investments, volatility can also be driven by speculative
investors such as hedge funds. Hedging currency risk, i.e. eliminating the
currency impact on returns and focussing on the underlying return, is sometimes
considered by investors. This can add to certainty but also more cost. In many
cases, due to the inherent unpredictability of currency markets, hedging not
only detracts from returns, due to the increased costs, but often proves
to be the wrong action in hindsight.
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