This question, might be one of the most mis-understood topics about investing.
How much, or how little impact, choosing difference currencies have on your investments isn’t as obvious as many people think.
The key actually comes down to whether your portfolio is currency hedged, or not.
How does currency choice affect non-hedged investment funds?
The short answer – it doesn’t. This surprises most people.
The currency of your investment fund, is just a notional figure you’re using to value the basket of underlying holdings. You could value it in GBP, USD, bitcoin, silver, or even rice, if you wanted to – it’s just a number.
For non-hedged investments, the currency really doesn’t matter. It’s the growth of the underlying holdings that’s important.
Let’s look at an example….
Below I’ve taken the iShares Core MSCI World ETF, valued in pounds (SWDA), and valued in dollars (IWDA). The funds have around 1,500 global companies, spread across 23 different countries.
When the funds are valued in their own native currencies, we can see the performance is substantially different, with IWDA around 11% ahead of SWDA.
But now look at what happens when we value both funds in US dollars.
The performance is almost identical. The currency of the fund made no difference at all.
The currency of the underlying holdings did have some impact. That’s why the funds both performed better valued in USD, and worse valued in GBP.
As a global portfolio with around 70% of its holdings in the US, over the last year where USD devalued, it decreased the value of US holdings for international investors.
On the other side of the coin, when the US dollar devalued, it increases the USD value of international holdings for US investors.
And you would have received the same result, valued in dollars (or pounds), whichever fund you chose.
What about the impact on currency-hedged funds?
Currency hedged funds behave very differently.
The idea of currency hedging is so that both funds deliver the same return in their native currencies, regardless of the impact of currency fluctuations.
This time I’ve take the USD hedged (AGUG) and GBP hedged (AGBP) versions of the same iShares Core Global Aggregate Bond ETF. Again the underlying holdings are globally diversified.
Below both funds are valued in their respective currencies, USD and GBP. The performance is similar, the impacts of currency fluctuations have been removed from both portfolios.
So if an American investor bough the USD hedged fund, and a British investor bought the GBP hedged fund, both got the same result, in their own currencies.
But look what happens when you value them both in GBP – one of the funds goes haywire.
If you were a British investor that needed to fund retirement in GBP, selecting the wrong currency hedged fund (in this case USD) could be a disaster; it means you’re speculating on the currency, rather than just investing in the underlying assets.
But what does this really mean for investors?
The question isn’t about which currency to invest in – you should simply choose the currency you plan to spend in.
The real question is about when to currency hedge your international investments, and when not to.
Equities – Equity market returns, are usually far more volatile than currency movements. Essentially equity funds tend to outgrow currency movements, and given hedging comes with a cost (which reduces returns) it’s rarely worthwhile.
Bonds – Comparatively, bond returns are smaller and less volatile. It’s easy for a currency movement to wash-out the returns from a bond fund. So here currency hedging is essential, but it has to be hedged in the currency you plan to spend in.
What if I can’t invest in the currency I plan to spend in?
If you’re retiring somewhere exotic this can often be an issue. For example, let’s say you plan to retire in Malaysia.
There simply aren’t many investment funds available priced in Malaysian Ringgit, compared to the 10,000+ options in GBP or USD.
And those that are available in Malaysian Ringgit, are expensive, and regulated in an emerging market. Rather than low cost, and regulated in a highly developed country.
So for equity investments you’re better off choosing a fund denominated in a major currency like USD, GBP or EUR. And when you need to fund your living costs, converting the sale proceeds to local currency.
For bond investments, it’s a bit more nuanced and will depend on personal circumstances. But holding a couple of years of necessary spending in local currency, is a good starting point.
