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; request a free guide on NISAs from Hargreaves Lansdown

News
people
Arts and Entertainment
Game Of Thrones
Uh-oh, winter is coming. Ouch, my eyes! Ygritte’s a goner. Lysa’s a goner. Tywin’s a goner. Look, a dragon
tvSpoiler warning: The British actor says viewers have 'not seen the last' of his character
Arts and Entertainment
'New Tricks' star Dennis Waterman is departing from the show after he completes filming on two more episodes
tvOnly remaining original cast-member to leave long-running series
Sport
The Etihad Stadium, home of Manchester City
premier league

The Independent's live blog of today's Premier League action

PROMOTED VIDEO
News
Polly Borgen at the Tribeca Film Festival in 2012
peopleThe Emmy award-winner starred in Cape Fear, the Sopranos and Desperate House Wives
Sport
FootballGerman sparks three goals in four minutes at favourite No 10 role
News
Rumer was diagnosed with bipolarity, attention deficit hyperactivity disorder and post-traumatic stress disorder: 'I was convinced it was a misdiagnosis'
peopleHer debut album caused her post-traumatic stress - how will she cope as she releases her third record?
Life and Style
Couples have been having sex less in 2014, according to a new survey
life
Arts and Entertainment
tvReview: 'Time Heist' sees a darker side to Peter Capaldi's Doctor
Voices
Holly's review of Peterborough's Pizza Express quickly went viral on social media
voices
News
Dennis Rodman has confirmed he is not going to the Middle East to 'talk to with the leaders of Isis' as claimed in a recent satirical report
people
News
people'Bring It On' actress says her legal team will combat the 'vultures'
Sport
Radamel Falcao was forced to withdraw from the World Cup after undergoing surgery
premier leagueExclusive: Reds have agreement with Monaco
Arts and Entertainment
musicBiographer Hunter Davies has collected nearly a hundred original manuscripts
Sport
A long jumper competes in the 80-to-84-year-old age division at the 2007 World Masters Championships
athletics
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

    Senior BA - Motor and Home Insurance

    £400 - £450 Per Day: Clearwater People Solutions Ltd: **URGENT CONTRACT ROLE**...

    Market Risk & Control Manager

    Up to £100k or £450p/d: Saxton Leigh: My client is a leading commodities tradi...

    SQL Developer - Watford/NW London - £320 - £330 p/d - 6 months

    £320 - £330 per day: Ashdown Group: The Ashdown Group have been engaged by a l...

    Head of Audit

    To £75,000 + Pension + Benefits + Bonus: Saxton Leigh: My client is looking f...

    Day In a Page

    Scottish referendum: The Yes vote was the love that dared speak its name, but it was not to be

    Despite the result, this is the end of the status quo

    Boyd Tonkin on the fall-out from the Scottish referendum
    Manolo Blahnik: The high priest of heels talks flats, Englishness, and why he loves Mary Beard

    Manolo Blahnik: Flats, Englishness, and Mary Beard

    The shoe designer who has been dubbed 'the patron saint of the stiletto'
    The Beatles biographer reveals exclusive original manuscripts of some of the best pop songs ever written

    Scrambled eggs and LSD

    Behind The Beatles' lyrics - thanks to Hunter Davis's original manuscript copies
    'Normcore' fashion: Blending in is the new standing out in latest catwalk non-trend

    'Normcore': Blending in is the new standing out

    Just when fashion was in grave danger of running out of trends, it only went and invented the non-trend. Rebecca Gonsalves investigates
    Dance’s new leading ladies fight back: How female vocalists are now writing their own hits

    New leading ladies of dance fight back

    How female vocalists are now writing their own hits
    Mystery of the Ground Zero wedding photo

    A shot in the dark

    Mystery of the wedding photo from Ground Zero
    His life, the universe and everything

    His life, the universe and everything

    New biography sheds light on comic genius of Douglas Adams
    Save us from small screen superheroes

    Save us from small screen superheroes

    Shows like Agents of S.H.I.E.L.D are little more than marketing tools
    Reach for the skies

    Reach for the skies

    From pools to football pitches, rooftop living is looking up
    These are the 12 best hotel spas in the UK

    12 best hotel spas in the UK

    Some hotels go all out on facilities; others stand out for the sheer quality of treatments
    These Iranian-controlled Shia militias used to specialise in killing American soldiers. Now they are fighting Isis, backed up by US airstrikes

    Widespread fear of Isis is producing strange bedfellows

    Iranian-controlled Shia militias that used to kill American soldiers are now fighting Isis, helped by US airstrikes
    Topshop goes part Athena poster, part last spring Prada

    Topshop goes part Athena poster, part last spring Prada

    Shoppers don't come to Topshop for the unique
    How to make a Lego masterpiece

    How to make a Lego masterpiece

    Toy breaks out of the nursery and heads for the gallery
    Meet the ‘Endies’ – city dwellers who are too poor to have fun

    Meet the ‘Endies’ – city dwellers who are too poor to have fun

    Urbanites are cursed with an acronym pointing to Employed but No Disposable Income or Savings
    Paisley’s decision to make peace with IRA enemies might remind the Arabs of Sadat

    Ian Paisley’s decision to make peace with his IRA enemies

    His Save Ulster from Sodomy campaign would surely have been supported by many a Sunni imam