Currency exposure is a key concern for expatriates living overseas – for example, should you invest in the local currency, USD, EUR or GBP, and what difference will it make to your returns?
One of the compounding issues is that many expats don’t have a way of quantifying their currency exposure to determine whether there are opportunities to safeguard their wealth. Things become more complex if you have assets in one place, work and live in another, and hold funds or pension products elsewhere.
Chase Buchanan explains here what currency risk is, why it’s so important, and how you can take practical steps to protect your finances.
Currency Exposure in an Expat Investment Portfolio Explained
When we talk about currency risk or exposure, we’re referring to the potential that swings in currency values or sudden movements between currency pairs will negatively affect your assets (or liabilities) held in another denomination.
As a basic example, excluding the impacts of interest or inflation:
- Today’s GBP/USD nominal exchange rate is around 1.2, so a £10,000 fund in sterling is worth about $11,962.
- Ten years ago, that balance would have been worth approximately $15,852 based on an average exchange rate of 1.5852.
An investor planning to move to the US may have been well advised to transfer the fund to a comparable product held in USD rather than retaining a GBP fund that has depreciated with the strength of the dollar.
Of course, currency exchange rates change continually. Still, the concept remains that any fund held in one denomination may increase or decrease in real-world value if your primary currency is different. The level of exposure within your expat investment portfolio depends very much on your circumstances.
If you buy a property in Spain and receive income in USD but fund the investment with a GBP mortgage, your currency exposure is high since you have the volatility of three denominations to consider. This principle is important in investment because you are investing in the currency as well as the asset, fund or commodity.
European-based expatriates who invest solely in Euros have little exposure, but risk can arise in multiple situations, such as having a British pension fund but retiring overseas.
Practical Steps to Manage Currency Exposure
As a global wealth management specialist, Chase Buchanan is well versed in the advantages and drawbacks that currency risks can offer – but in most cases managing this risk is a case of having complete oversight of each client’s portfolio.
There are several ways to mitigate currency exposure or minimise the possibility of an adverse impact, not least being observant of macroeconomic factors that signal a potential shift in exchange rates.
Currency fluctuations may be advantageous rather than detrimental, and transitioning funds to favourable economies may be viable following a portfolio review – learn more in our guide, Six Steps to Prevent an Investment Portfolio Plateau.
Determining Your Base Currency
Your base currency is the denomination you use most, which ties into your biggest financial goals. Expatriates purchasing a home in Spain, for example, have Euros as their base currency.
Calculating Currency Exposure
The next step is to analyse currency exposure linked to each investment asset you intend to use to finance an activity. If you plan to finance education costs in the UK, you may wish to assess whether holding the financing investment in Euros is the ideal solution.
An investment adviser can help calculate your true exposure, particularly if your portfolio includes mutual funds, ETFs or multinational company shares.
Diversifying Investment Portfolios
Diversification is a core concept in robust wealth management, and in some scenarios, it may be preferable to split portfolios to finance different goals with the appropriate currency.
Investment pools within an expat investment portfolio can match currency exposure with the expense currency they are intended to fund.
Hedging Against Currency Risk
Another approach is to build in a hedge for any fixed-income element of your portfolio since currency movements are often most impactful on longer-term static return products. Equity investments can be less exposed to currency volatility, although diversification between industries, countries and asset classes remains important.
Some expatriates may not know which currency future liabilities will be in (such as healthcare, education, property or living expenses) if they haven’t made any finite retirement decisions or are considering a possible future relocation.
In this case, an investment adviser can assist with building a well-balanced portfolio, weighted towards your potential choices, to preserve flexibility without investing solely into assets in one jurisdiction.
Currency Speculation as an Investment Strategy
While there are many ways to prevent currency exposure from affecting your wealth and investment portfolio, currency management is primarily a way to reduce risk rather than a high return approach.
Currency speculation varies significantly from other products such as stocks or bonds because where one currency appreciates, the other will depreciate, so there isn’t as much long-term potential for healthy returns.
It can also be very difficult to make accurate predictions as to currency movements, given the complexity of politics and other variables.
Expert Support in Understanding and Managing Currency Risk
Multi-currency investment portfolios with a controlled balance of assets and products will always assume some level of risk as part and parcel of investment, but the aim is to maximise returns without accepting a higher risk than necessary.
Dramatic swings in exchange rates can diminish returns where longer-term investments are held in a different currency than your primary spending, so it is important to understand. Buying power refers to the true value of your assets and wealth, allowing you to spend or invest in outgoings.
So, if the bulk of your portfolio is in a different currency than your base currency, it is advisable to conduct a portfolio review to determine whether any changes are necessary.
In a globalised financial market, there are numerous ways to build an efficient portfolio based on your goals, timelines and expectations.
For more information about assessing your currency risk, aligning investments with your plans or reviewing your current assets, please contact Chase Buchanan at your convenience.