FX – the hidden portfolio risk, says Record Currency Management
The vast majority of the international equity return for US dollar investors has come not from the asset class but from the currency exposure over the past decade and investors may be dangerously unaware of this, according to Record Currency Management.
Analysis by Record Currency Management shows investors in assets priced in major currencies such as the US dollar, but also the euro, have cyclically made significant gains on the basis of their currency exposure over the years, only to give it back in following years – proving the hypothesis that developed market currencies, on an unmanaged basis, are largely a ‘zero sum game’ in the long term.
Euro (or pre-euro Deutschmark) investors allocating to non-European shares (MSCI World ex-EMU) made up to 50% on FX between 1980 and 1984, but then lost all this by 1995, before making it again by 2000 – then losing it again by mid-2007. By December 2011 the total FX return was a mere 0.4% per year.
The results for Swiss franc based investors in MSCI World ex-CHF were much the same, ending the 31-year period with a 0.7% per annum gain on their FX.
James Wood-Collins, Record Currency Management’s CEO, says: “We recommend generally investors should think about currency risk and take appropriate courses of action.
“An investor with a relatively long-term investment horizon and the ability to manage cash flows from a hedging program may well choose to hedge. By contrast, a US investor who chooses to remain unhedged now in expectation of foreign currencies strengthening further versus the dollar is taking a strong tactical view. We would argue they should realise they are taking that view.
“The danger is if we expect long-term cyclicality, but people only look at the last five to seven years you can make the wrong decision at the wrong time.”
His words came shortly after the tenth anniversary, in February, of the US dollar reaching a peak against a global, trade-weighted basket of currencies all adjusted for relative inflation.
Apart from a brief lower spike around the time Lehman Brothers collapsed, it has been pretty much all downhill – by about 25% – for the Greenback since.
That has affected bond investors just as it has affected equity investors, wherever their exposure involved the US dollar.
During the fall, dollar investors holding non-dollar assets have done very well and profited by the relative strength of non-USD currencies, Wood-Collins says.