Investing internationally offers geographical diversification. In other words, helps spread investment risk. However, it also introduces another factor that can impact your investment return; exchange rate risk.
Opting to invest in shares outside the UK gives you access to different industries, economic cycles, levels of productivity, trade flows, inflationary trends, interest rates and more. All of these help to increase the diversification of your portfolio and spread your risk more effectively.
Currency fluctuations can work for and against you
Investing in international markets can be volatile and this volatility is driven by multiple factors, but one that is often forgotten is the impact of currency. Your home or base currency can and will impact the level of your investment return.
The table below illustrates this for the S&P 500 index. The return you get depends on the currency it’s shown in.
Performance of the S&P 500 index in different currencies
Source: Vanguard, using data from Factset
Understanding how currency fluctuations relate to your investments
Typically, UK investors operate in pounds sterling (GBP). So, if you buy shares in an overseas company, your funds must be converted into the respective currency of the region where that company is based.
As an example, if you invest in a US company, your money will be converted into US dollars when purchasing the shares.
When you later sell your shares, the proceeds will be converted back to sterling as part of the settlement process (cash arriving back in your account).
Currency fluctuations can work to strengthen investment returns
As an example, while your money is invested in US shares, your money remains in US dollars, so the value of those dollars constantly fluctuates relative to sterling. This will be happening regardless of how the company or fund you’re invested in is performing.
Exposing your money to currency fluctuations as well as the inherent movements of equity investments can create an additional source of return, both positive and negative.
Should the value of the dollar increase relative to the pound, as it did during the first phase of Covid-19 in 2020, you’ll make more money because you’ll end up with more pounds per dollar when you sell.
However, if the dollar weakens against the pound, as it did during 2021, you’ll get fewer pounds back.
A worked example:
- You buy $100 worth of ‘US company A’ when the GBP/USD exchange rate is 1.30 – this costs you £76.92 in sterling
- Share prices in ‘US company A’ increases by 20% to $120
- You decide to sell to realise your profit, but the GBP/USD exchange rate has moved to 1.56 (in other words, GBP has strengthened by 20%)
- Your actual return is 0% as $120 converted back to GBP at an exchange rate of 1.56 equates to £76.92 – the exact same amount that you started with.
The same will apply to investments held in any other foreign currency that will ultimately have to be exchanged back into sterling.
In summary, if the overseas currency strengthens against the sterling, your return increases. If, however, the overseas currency weakens against sterling your return decreases and vice versa.
Currency movements swing both ways
Currency movements are influenced by multiple factors, from economic cycles to interest rate expectations.
Currency is something that most household investors do not consider but is something that, as professionals, we factor into our everyday management of an investment portfolio.
Managing currency risk and your investments
At Bowmore, our investment managers factor currency fluctuations into all our investment decisions. Our active management style means we remain agile and proactive, always acting based on current conditions and situations.
When investing in foreign shares we can choose whether to expose your investments to currency fluctuations or not (we can use a simple hedge to negate any currency risk) depending on our outlook and the prospects for certain currencies.
The important thing to remember is that if you fail to consider the impact of currency, you could get lucky and see it work in your favour.
If it works against you, you might think you are getting a positive return, but you could end up seeing your return eroded or negated due to currency movements.
For many, this is just another complication they could do without when it comes to managing investments. For us, it is part and parcel of running a simple and effective investment portfolio designed to provide consistent and positive outcomes.
Get in touch
Bowmore Asset Management specialise in building and managing investment portfolios for private clients, trusts and charities. We invest across all major asset classes, including equities, fixed interest, hedge funds, commodities and property funds.
To find out more about how we can help you invest and benefit from exposure to different currencies while ensuring your portfolio is well-diversified and balanced according to your appetite for risk, get in touch. Email enquiries@bowmoream.com or call us on 0203 617 9206.
The value of your investments can go down as well as up, so you could get back less than you invested.
Past performance is not a guide to future performance.
Bowmore Asset Management Ltd is authorised and regulated by the FCA.
