Sarah Coles: No investor can afford to ignore currency risks entirely
Sarah Coles is a personal finance analyst at Hargreaves Lansdown.
When you hold overseas investments, the value of your investment doesn’t just depend on the performance of the stock itself, but of the underlying currency too.
It means no investor can afford to ignore currency risks entirely.
However, the kind of investor who needs to check currency movements on a daily basis, and embark on complex currency hedging strategies, is few and far between.
Most people just need to understand the risks they’re taking and mitigate any they’re uncomfortable with.
Are your investments spread out widely enough around the world?
The first step is to consider the geographical diversification of your whole portfolio, including overseas shares and funds.
For most long-term investors, the aim will be to have broad geographical diversification, so if your holdings are concentrated in one particular area, you need to be aware of the currency risk you’re exposed to and consider whether you would benefit from more diversification.
The benefit of spreading your risk this way is that fluctuations in one particular currency may be cancelled out to some extent by movements in another.
How closely should you watch currency movements?
Once you’re sufficiently diversified, if you’re a long-term investor, you may take the view that you’re prepared to take the rough with the smooth.
While there will be fluctuations in currencies in the short term, when you’re investing for 5-10 years or more, these short-term changes have less of an impact.
For these investors, when you regularly revisit your portfolio, considerations of currency movements should form part of your review, but it shouldn’t be the kind of thing you worry about on a daily basis.
Can you take advantage of currency fluctuations?
If you’re holding shares and trading tactically, you may take a different view.
Some people will actively seek to benefit from currency movements they’re anticipating.
They might, for example, expect the dollar to rise against the pound, so they add to their US holdings.
However, it’s worth bearing in mind that currency markets move according to a myriad of different factors, including sentiment, so calling the market is notoriously difficult.
Others may want to time the exchange of currencies.
Riding out currency moves: Once you’re sufficiently diversified, if you’re a long-term investor you may take the view that you’re prepared to take the rough with the smooth
Some trading systems allow you to hold overseas currency, so you can sell one dollar-denominated share and buy another, without converting back into sterling, or you can sell up and hang onto your dollars until you’re happy with the exchange rate.
And some investors will want to hedge their currency risk. One option is to do this through a specialised exchange traded fund, which is designed to track the movement of a currency.
This is a niche strategy though, so not one that most investors will consider.
