Only the brave venture abroad

CURRENCY TURMOIL

Yet again, the financial world is being convulsed by huge currency movements. The European Exchange Rate Mechanism seems to be falling apart following the peseta devaluation last week and the prospect of a franc and lira crisis looming in the near future. The dollar has also plunged against the mark, while the yen is the only major currency that looks at all stable. The Mexican peso and the Brazilian real, meanwhile, look bent on self-destruction as they head to ever lower lows.

Confused? You should be. Economists and currency experts certainly are since many have been caught embarrassingly on the hop by recent develoments.

But where does all this leave the poor benighted private investor who thought it might be nice to have a few US Treasury bonds or German equities in his portfolio? In the space of three days the dollar fell from $1.50 to $1.62 against sterling early this week while the ERM, a system specially designed to minimise currency fluctuations, is manifestly failing to do so. Do currency movements simply pose too great a risk for it to be worth private investors dabbling in foreign markets?

The answer is that it can be worth it, but it depends on how you do it. Around 90 per cent of UK investors have no overseas exposure at all. They take the view that they know too little about foreign markets to make sensible judgements about them and that staying in their home currency is safest.

But overseas investment can actually be a way of diversifying risk in a portfolio so that you are not slavishly dependent on the performance of the UK economy alone. Moreover, if you get it right, the returns from investing overseas can be spectacular: anyone who put their money in the Gartmore Pacific Growth Fund 10 years ago, for instance, would have seen it grow by 628.9 per cent.

It is, though, an area full of caveats. The problem is that you not only have to choose the right markets, you have to get the right currencies, too. Since the Tokyo stock market has moved little in the past five years, Japanese equity investments would have produced fairly poor returns over that time were it not for the fact that the yen has appreciated by some 40 per cent. Most of the return for a UK investor, who would have bought and sold in yen, has been from currency appreciation.

This effect is magnified several times over when it comes to developing countries, where currencies tend to move more wildly. Emerging markets, therefore, represent a far bigger exchange-rate bet. Witness the 50 per cent fall in the peso since December compared with the recent 7 per cent "crisis" devaluation in the peseta.

Since the easiest way to invest abroad is through a unit or investment trust, it is important to know what the policy of the fund is towards currency hedging - in effect, insuring itself against adverse movements of currencies against sterling. Funds that hedge most of the risk will be considerably safer than funds which do not.

Morgan Grenfell Asset Management is one fund manager whose policy is not to hedge. The reason is they consider it too expensive. "In buying a hedge for currency, you're betting that the exchange rates will stand still," said a manager. "It's simply not worth it because if the rates move you are missing out on an opportunity to make money. We like to keep the risk profile of the fund down by not taking on another bet. Hedging is just another risk."

Robert Fleming Asset Managment is at the other end of the spectrum, hedging most of its currency risk as a matter of course. "We actively manage our funds, which means we are actively managing the risk in the funds," says Tim Knowles, manager of the Save & Prosper International Bond Fund (run by Flemings). "That, of course, implies that we hedge currencies to control risk."

The only time Robert Fleming departs from its hedging policy is when it has a positive view in a particular currency, in which case it takes out a deliberate exposure to it. If it expects the yen to rise, for instance, it will not hedge its yen exposure, which would have nullified any benefit from the currency's improvement. "We try to strike a happy medium between having a diversified bond portfolio and a risk-free, fully hedged investment," says Mr Knowles.

As with an unhedged fund, this policy has its dangers. The S&P International Bond Fund, for example, took a bullish view of the dollar recently with the result that it is 40 per cent invested in dollars and only 3 per cent in marks. "Over the last week or so our currency policy has not been right," concedes Mr Knowles, although he continues to believe the dollar will strengthen again later this year.

The S&P fund, however, also has a relatively high exposure to sterling because it measures its performance in terms of the return in sterling. Some funds, however, measure themselves against an international index such as the Salmon Bond Index in which sterling plays little part. These funds may have less than a 10 per cent exposure to sterling. Since they have a higher exposure to foreign currencies, their exchange-rate risk is likely to be considerably higher.

Investors trying to pick an overseas fund should also bear in mind that there is a big difference in the importance that currency risk plays between equity and bond funds.

Equities are, in general, more volatile than bonds. Equity fund managers estimate that share price movements account for 60 to 70 per cent of the risk in their funds. The rest is accounted for by exchange-rate movements.

In bond funds, however, the risk profile is the other way around. Most of the risk is from currency movements while only 30 to 40 per cent is from changing bond prices. In other words, the performance of a bond fund is far more likely to be affected by currency movements than that of an equity fund. Not surprisingly, bond funds are more likely to hedge their currency risk to minimise their overall volatility. It is, however, essential to know how currencies are handled in a bond fund before investing in one.

Finally, the cardinal rule for overseas investment is to take a long- term view. Over five years, currency swings may more or less cancel each other out, making exchange-rate movements a relatively unimportant factor.

But over the shorter term, say a year, the chances of being badly stung are high. It is only the brave who take on the markets at this game.

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at VouchedFor.co.uk

Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Guru Careers: Pricing Analyst

    £30 - 35k: Guru Careers: We are seeking a Pricing Analyst to join a leading e-...

    SThree: Trainee Recruitment Consultant

    £20000 - £25000 per annum + OTE £45K YR1: SThree: At SThree, we like to be dif...

    SThree: Trainee Recruitment Consultant

    £20000 - £25000 per annum + competitive: SThree: Did you know? SThree is a mul...

    Guru Careers: C# Project Team Lead

    £55 - 65k (DOE): Guru Careers: A unique opportunity for a permanent C# Develop...

    Day In a Page

    Fifa corruption: The 161-page dossier that exposes the organisation's dark heart

    The 161-page dossier that exposes Fifa's dark heart

    How did a group of corrupt officials turn football’s governing body into what was, in essence, a criminal enterprise? Chris Green and David Connett reveal all
    Mediterranean migrant crisis: 'If Europe thinks bombing boats will stop smuggling, it will not. We will defend ourselves,' says Tripoli PM

    Exclusive interview with Tripoli PM Khalifa al-Ghweil

    'If Europe thinks bombing boats will stop smuggling, it will not. We will defend ourselves'
    Raymond Chandler's Los Angeles: How the author foretold the Californian water crisis

    Raymond Chandler's Los Angeles

    How the author foretold the Californian water crisis
    Chinese artist who posted funny image of President Xi Jinping facing five years in prison as authorities crackdown on dissent in the arts

    Art attack

    Chinese artist who posted funny image of President Xi Jinping facing five years in prison
    Marc Jacobs is putting Cher in the limelight as the face of his latest campaign

    Cher is the new face of Marc Jacobs

    Alexander Fury explains why designers are turning to august stars to front their lines
    Parents of six-year-old who beat leukaemia plan to climb Ben Nevis for cancer charity

    'I'm climbing Ben Nevis for my daughter'

    Karen Attwood's young daughter Yasmin beat cancer. Now her family is about to take on a new challenge - scaling Ben Nevis to help other children
    10 best wedding gift ideas

    It's that time of year again... 10 best wedding gift ideas

    Forget that fancy toaster, we've gone off-list to find memorable gifts that will last a lifetime
    Paul Scholes column: With the Premier League over for another year, here are my end of season awards

    Paul Scholes column

    With the Premier League over for another year, here are my end of season awards
    Heysel disaster 30th anniversary: Liverpool have seen too much tragedy to forget fateful day in Belgium

    Liverpool have seen too much tragedy to forget Heysel

    Thirty years ago, 39 fans waiting to watch a European Cup final died as a result of a fatal cocktail of circumstances. Ian Herbert looks at how a club dealt with this tragedy
    Amir Khan vs Chris Algieri: Khan’s audition for Floyd Mayweather may turn into a no-win situation, says Frank Warren

    Khan’s audition for Mayweather may turn into a no-win situation

    The Bolton fighter could be damned if he dazzles and damned if he doesn’t against Algieri, the man last seen being decked six times by Pacquiao, says Frank Warren
    Blundering Tony Blair quits as Middle East peace envoy – only Israel will miss him

    Blundering Blair quits as Middle East peace envoy – only Israel will miss him

    For Arabs – and for Britons who lost their loved ones in his shambolic war in Iraq – his appointment was an insult, says Robert Fisk
    Fifa corruption arrests: All hail the Feds for riding to football's rescue

    Fifa corruption arrests

    All hail the Feds for riding to football's rescue, says Ian Herbert
    Isis in Syria: The Kurdish enclave still resisting the tyranny of President Assad and militant fighters

    The Kurdish enclave still resisting the tyranny of Assad and Isis

    In Syrian Kurdish cantons along the Turkish border, the progressive aims of the 2011 uprising are being enacted despite the war. Patrick Cockburn returns to Amuda
    How I survived Cambodia's Killing Fields: Acclaimed surgeon SreyRam Kuy celebrates her mother's determination to escape the US

    How I survived Cambodia's Killing Fields

    Acclaimed surgeon SreyRam Kuy celebrates her mother's determination to escape to the US
    Stephen Mangan interview: From posh buffoon to pregnant dad, the actor has quite a range

    How Stephen Mangan got his range

    Posh buffoon, hapless writer, pregnant dad - Mangan is certainly a versatile actor