Currency Effects

By ,   June 26, 2014

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For many investors, a “Home Country” bias has dominated their portfolio, because it is more comfortable to invest in companies and brands with whom you are familiar.  However, as information flows more freely across the global, and markets become more integrated; international investing is taking on a larger role in an investor’s portfolio.

One aspect of international investing that is often overlooked is the effect of currency movements on foreign assets.   Currency investing can be especially difficult to navigate as currencies trade on a “relative” basis – i.e. if one currency in a pair is going up, the other is going down.  More importantly, investors need to understand that if currency effects are not considered, potential gains can be eroded.  Let’s look at a quick example: 

Suppose you invest in a German company and the stock returns gains 10% in local currency terms.  However, during the same investment time period, the Euro depreciates (goes down) 10% relative to the U.S. Dollar.  So your total return, as a U.S. investor, is actually 0%, because the positive company gains were wiped out by negative currency effects.  

The same is true on the other side.  IF the Euro had appreciated (went up) 10% relative to the U.S. Dollar; total return would have been +20%.  

Therefore when choosing an advisor or money manager to work with, be sure to ask what their philosophy is on currency management and how those risks will be managed in your portfolio.