Financial Times Guide to Investment Trusts: Unlocking the City's Best Kept Secret (Financial Times Series) by John C Baron

Author:John C Baron [Baron, John C]
Language: eng
Format: mobi
ISBN: 9781292005096
Publisher: Pearson Education Limited
Published: 2013-08-27T00:00:00+00:00

Currency considerations

Most UK investors will think in sterling because their assets and liabilities are based in the UK. Accordingly, they tend to have the majority of their portfolio invested in the UK. But some investors may have assets or liabilities based abroad, and may consequently want to hedge their currency risk – so not to lose money because of currency swings – by having portfolio exposure in that particular country or currency.

This can be done by investing in equities, bonds or indeed cash denominated accordingly in the chosen currency, or by investing in funds specialising in the country where the currency exposure is not hedged. Such considerations can often influence investment weightings within a portfolio.

But investors may also think other currencies are attractive as an investment in their own right, and want to benefit accordingly within their portfolios. As such, it is always worth investigating whether an investment trust is hedged or not – because this can have a big impact on portfolio returns.

If un-hedged then, regardless of how well the underlying portfolio performs relative to its own index or stock market, its total value will be influenced by swings in the local currency relative to the pound. A 10 per cent gain in the portfolio will be lost if the local currency weakens by more than 10 per cent against the pound. But it can also work the other way. A local currency, in whose market a portfolio is invested, which strengthens against the pound can enhance the returns gained from that portfolio.

By contrast, a hedged portfolio is, by and large, not influenced by currency moves because the fund manager has ‘pegged’ the local currency to sterling via the derivatives market. Swings in the portfolio’s currency will not affect the total value when it is transferred back into sterling. In one respect, this reduces risk, for currencies are notoriously difficult to predict, particularly in the short term.

The key reason for this is that politicians, including the central bankers appointed by them, are an additional factor – over and above economics – that can disproportionately influence matters. And politics can add an unpredictable mix to the economic equation. For example, if economics was left to prevail, the euro would have fractured by now – with countries like Greece having defaulted and left the single currency. But the single currency has a political dimension – that of ‘ever closer political union’, as described in the Treaty of Rome. Therefore, economics takes a back seat to a very large extent.

I prefer to look at the longer-term factors that influence currencies, and which usually prove the more powerful. Strong currencies are typically the hallmark of countries with strong finances, a positive balance of trade and sound politics: one reason being that these countries do not usually have to buy other currencies, and therefore sell their own, to fund debt or trade deficits. Whatever the meddling of politicians or central bankers, the realities of the market usually prevail.

It is no coincidence that a number

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