The Importance of Currency when Investing
Written by Jonathan Wade
Director
Financial technology lets us do wonderful things.
Within 10 minutes of opening a stocks and shares ISA, you can happily be making investments around the world. US government bonds, European ETFs, Japanese equities, whatever you like.
And lots of people do just that – diversifying abroad, and rightly so.
But they often forget that they aren’t making a single investment when they decide to do so.
They’re actually making two investments. One into the asset they want – and the second into the currency of that asset.
And we’re not talking here about Venezuela or Argentina or Turkey. We’re talking about the major currencies of major countries.
Here’s the return of the Japanese stock market since the start of 2020; the COVID wobble we saw everywhere, then a nice steady climb up to a 50% gain as of today. It’s an annual return of around 11.5%. Looks good!
Source Factset7IM
And if you like your returns in Japanese Yen, it IS good.
But I suspect you probably pay for most of your stuff in GBP.
That’s what the purple line shows – the Japanese stock market returns, translated back into pounds sterling.
Source Factset7IM
That’s a 16% return over the period. Just over 4% annualised. The foreign exchange markets took 7% of your returns away each year!
Of course, there are periods where the currency will move in your favour too, but this highlights how variable the outcome can be when you put a border between you and your investment!
The key thing to remember is that when people talk about a market or a stock moving by x% in portfolios, that’s not the whole story. If you have to convert this back into pounds, the whole picture could change.
Core multi asset funds are at the heart of all our client portfolios and these actively managed funds evaluate not only the relative attractiveness of an asset class, geographical sector and individual investment, but also the currency of that investment. Currency risk (or opportunity) is, in particular, an ever-present aspect of investing in commodities such as oil or gold, as most commodities are traded in US dollars. Our core multi asset funds may choose to hold an asset in its native currency with an aim of benefitting from future currency fluctuations, or alternative they may choose to ‘hedge’ against currency risk (a type of insurance) to avoid the potential for currency losses.
Based on an article by 7IM