Currency

How Currency Movements Impact Investments

Foreign currency fluctuations are volatile, often changing minute-by-minute, but few investors understand how these sometimes minuscule rises and falls impact on their pensions and investments.

The ebb and rise of a currency can have a big influence on the value of investments and is a long term risk that many investors ignore, mainly because they do understand how the markets work.

In a bid to help investors, Rob Morgan, a pension and investments analyst at Charles Stanley Direct explains how currency movements can affect funds.

He also points out that investors need to understand when and how fund managers hedge against currency movements to try and even out exposure.

Most investors who buy in to a global equity fund have an unhedged exposure to foreign currency exchange rate changes.

Bonds and hedging

Morgan gives the example of how an unhedged fund is affected by movements in the US dollar.

“If the investment is held in dollars, and the dollar rises 3% on the day and at the same time falls 1% against the pound, the movement is 2%,” he said.

“If the investment was hedged, the return would be 3% less the expense of hedging the holding. British investors want sterling to weaken and purchase less foreign currency as these increases the value of the holding in dollars, euros or whatever currency the fund is denominated in.”

Bond investors, except global bonds, will find their holdings are typically hedged as investment rules call for 80% of the fund should be in pounds or hedged.

As bonds are less likely to react to short-term currency shifts, these investments are favoured for returning an income.

“Where bonds are hedged the transactions are probably through derivatives that move in the opposite direction to the currency the bonds are held in,” said Morgan.

Equities and hedging

Big movements in the Japanese stock market and the yen show how hedging can work against an investor.

Although Abenomics has boosted the economy and seen big rises in share prices, the yen has also considerably devalued against a basket of leading currencies, including the pound. This devaluation has watered down returns on shares for unhedged sterling investors.

“Many equity investors prefer non-hedged funds as currency movements tend to even out in the long-term,” said Morgan. “Not only that, but few would have predicted the change in the fortunes of the yen in recent months and hedging a fund adds extra costs that have to be considered when thinking about the likely profits.”

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