Posted by Liz Rees in Risk & Diversification category on 05 Feb 16
How do currency movements affect returns from overseas investments?
The table below, included in our recent market commentary, reminds us of the significant impact that a weak currency can have on your
annual returns. It is evident that in 2015 hedging your Euro exposure would have been a good strategy as it lost ground against sterling whilst
the reverse was the case for the Japanese Yen and the US Dollar.
Calendar year 2015
% total return
MSCI
World
S&P
500
FTSE
All Share
FTSE
Euro First 300
Nikkei
225
Shanghai
Composite
Local currency
1.3
0.8
1.0
8.5
9.1
9.4
Pound sterling
3.3
6.6
1.0
3.0
13.3
10.6
Source: FE Analytics
The considerable disparity between currency adjusted returns from different markets has been partly attributed to the divergence of Central
Bank monetary policy in major economies. However, we should remember this is just a snapshot in time and making judgements about future
currency trends can be even more difficult than trying to time equity investments! The next table illustrates how hedging currency exposure to
the Euro and the Yen would have been beneficial in the first half of 2015 but not in the second half of the year.
Total Returns
FTSE Eurofirst 300
Nikkei 225
H1 2015
H2 2015
FY 2015
H1 2015
H2 2015
FY 2015
13.0
-4.0
8.5
16.0
-5.9
9.1
3.2
-0.2
3.0
11.9
1.2
13.3
Local currency
£ sterling
Source: FE Analytics
The poor performance of the Euro of late has been attributed to the Eurozone lagging behind other countries in its agenda of interest rate cuts
and implementing Quantitative Easing (QE). The Yen has strengthened considerably since mid-2015, following a long period of weakness,
which could be due to its perception as a ‘safe haven’ in Asia following the devaluation of the Renminbi by the Peoples Bank of China.
Since the start of 2016, Sterling has weakened against all 3 major currencies after the Bank of England made it clear that UK interest rate
rises have been deferred until the economic outlook is clearer. Meanwhile, the US Federal Reserve delivered the first rate rise in a decade in
December.
Looking beyond short term movements
Longer term charts also paint a mixed picture. Looking at a 5 year time-frame, for example, the Yen and the Euro lost 33% and 12%
respectively against the Pound but the US dollar gained nearly 6%.
However, if we consider the movements over 10 years), as illustrated in the next chart, all these currencies appreciated against the Pound with
the US dollar +16%, the yen +14% and the euro +7%.
If I’m concerned about currency weakness in my chosen market what can I do?
You could consider a hedged share class. However, although these have become more popular in recent years with a number being added,
they are still not widely available and many leading fund providers do not offer them at all. Providers with a reasonable range of hedged
share classes include Schroders and JP Morgan and they are most common in the European and Japan IA sectors. To search for the full
range of funds with hedged share classes on the Willis Owen platform simply type ‘hedge’ into the search box in our Fund Space facility.
What are hedged fund share classes?
A hedged share class aims to protect your returns when translated back into your ‘home’ currency by the use of financial instruments such as
forward contracts. Currency hedging can never be completely accurate, so if you invest in a hedged share class you will only minimise your
currency exposure, not remove it completely. Currency hedging does not result in any additional Annual Management Charges to investors
but the fund will bear the costs and expenses of the currency hedging transactions.
Moreover, it is important to remember that you will only benefit if the overseas currency which you are hedging weakens. If it should move in
the other direction you will lose out from any currency gains that may occur. For example, if you invest in a European equity fund hedged to
sterling and the Euro strengthens against the Pound you will not benefit from this foreign exchange rate movement as you are not exposed to
it. Of course, if the euro depreciates against sterling you will not suffer the negative impact of this movement.
A non-hedged share class has the opposite effect and your returns will be enhanced if the currency to which you are exposed strengthens and
you lose out if it depreciates. Most investors are comfortable with unhedged currency exposure given the difficulty of forecasting currency
trends.
Have hedged share classes done better than unhedged ones?
Most hedged classes have not been around for 10 years so it is difficult to quantify the long term outcomes. The table below compares the
performance of each share classes across a number of funds from JP Morgan (as they have one of the widest ranges of hedged classes).
Unsurprisingly, given the currency trends highlighted above the hedged classes have been most effective for Japan and European funds in
protecting returns in Sterling terms.
Total Return
Share
Class
2011
Hedged
Unhedged
2012
Hedged
Unhedged
2013
Hedged
Unhedged
2014
Hedged
Unhedged
2015
Hedged
Unhedged
Source: FE Analytics
JPM Europe
Dynamic Acc.
JPM Japan
Acc.
JPM Global Equity
Income Inc.
JPM US Equity
Income Inc.
N/A
-0.2
N/A
7.8
N/A
0.7
N/A
8.7
21.7
-7.6
12.0
8.6
21.8
-6.9
11.2
5.6
42.3
57.5
24.3
32.6
37.8
38.6
19.8
29.6
8.7
8.6
8.5
14.7
1.2
1.3
9.3
21.4
12.9
22.9
4.0
-2.6
8.5
28.3
6.3
2.3
We can also see that that selecting a good fund manager can be just as important, if not more important, than choosing a hedged share
class. For example, in the 3 year period shown below, opting for one of the hedged classes available in the European sector would have
undoubtedly enhanced your Sterling returns but there is also a wide divergence between performance of managers whichever fund class you
choose.
Total return
%
31.12.2012 31.12.2015
FP Argonaut
European
Enhanced Income
I Acc
Artemis
European
Opportunities
I Acc
JPM Europe
Dynamic
Ex UK
C Acc
Schroder
European Alpha
Plus
Z Acc
Hedged
57.4
56.3
74.7
34.2
Non –hedged
40.6
42.7
51.4
20.8
Source: FE Analytics
Can fund managers make hedging decisions for me?
A diversified portfolio is important to ensure you are not over exposed to the trends in a particular currency. Obviously, if you invest in a global
fund you will be spreading your currency exposure across a range of markets. Some multi asset funds also take currency positions as part of
their investing strategies.
Very few country specific funds have active hedging strategies within their fund management remit although the manager may take his views
on currency into account when positioning the fund. For example, if he expects the local currency of the market to weaken he may increase
weightings in sectors and companies which are more dependent on exports.
A notable exception is Neptune Japan Opportunities fund. Here the fund manager has held a long term hedge on his Yen exposure reflecting
his negative view on the currency. The intention to use this approach is laid out in the KIID (Key Investor Information document) with the
document section of Fund Space:
‘The Manager aims to remove the impact of changes in exchange rates between the Yen and Pounds sterling by hedging, a currency
transaction which can protect against such movements. However, if exchange rates move contrary to the Manager’s expectations this can
have a significant negative impact on the value of your investment.’
This strategy has made a very positive contribution to performance over the long term but has been a significant detractor since mid 2015
when the Yen started to weaken. To ascertain whether a fund undertakes active hedging it is important to read the KIIDs on our website.
Conclusions
Currency movements are volatile and not easy to predict. If we look at the Euro and the Yen over the longer term they have both gone through
periods of strength and weakness so you would need to taken an active stance on the currencies to really benefit. A hedged class will only
provide a one way bet and doesn’t change it’s positioning over time. Therefore it is probably best to think about choosing a hedged class only
if you are particularly concerned about protecting yourself from the downside of currency weakness in your chosen market or believe the
Pound is likely to exhibit prolonged strength against most other currencies.
Research to identify the most suitable fund for your requirements should be carried out ahead of any decision to opt for a hedged class.
However, if you still have a strong view on the future trend of a particular currency it may then be worth seeing if a hedged class is available.
Another factor to bear in mind is that while a weak currency in the region where your fund invests will affect your returns on translation, if the
companies held in the fund rely on exports they should benefit. For example, many Japanese businesses are heavily dependent on overseas
sales so will be at an advantage when the Yen is weak as their goods will be cheaper abroad and hence more attractive to consumers. This
should be good news for their share prices!
The frequent divergence of different currencies supports the argument for ensuring that you have a diversified portfolio by geography as well
by asset class. Funds should be seen as a long term investment and just as a country’s stock market performance will vary over economic
cycles it is likely that the currency will also fluctuate. By investing in a range of funds across a number of regional markets, or alternatively a
global fund or multi asset fund, you should be able to achieve a smoothing out of both sources of volatility over time.
Important Information: We do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure
whether to invest, you should contact a financial adviser.
© Willis Owen 2017
Important Information
Willis Owen Limited does not offer or provide advice as to the suitability of investments.
If you are unsure whether an investment is suitable for you, or require any advice with regard to your investments you should obtain expert financial advice.
Past performance of an investment is not a guide to future performance.
The value of investments or income from them may go down as well as up. You may not necessarily get back the amount you invested.
Willis Owen Limited is authorised and regulated by the Financial Conduct Authority.
Willis Owen Limited is entered on the Financial Services Register under reference number 121261.
The information and content of this site is intended for UK consumers and is subject to the UK regulatory regime.