With the pound falling against the US dollar and some commentators predicting parity next year it is worth considering what this means for your investments and how to apply to your investment strategy
. Currencies are not like shares or bonds, they do not pay dividends or interest, there is no expected return from them. However currency movements can have a big impact on your investments when those investments are converted back to your local currency that is UK pounds.
No one has the ability to correctly and consistently predict foreign exchange movements. As Alan Greenspan, former US Federal Reserve Chairman said, currency forecasting is no better than tossing a coin.
So the question is what to do and as always the answer is to hold a globally diversified portfolio of investments denominated in the local currencies. In this way you also diversify away the exchange rate risk as some currencies will appreciate against the pound, like the US dollar is at the moment. This means that equities quoted in dollars will rise in value simply because the dollar is appreciating against the pound. When the investment is converted back to pounds sterling the now higher value dollar will buy more pounds. The reverse is true where the pound is appreciating against a currency as it is against the Euro at the moment.
Our standard investment portfolios are made up of funds managed by Dimensional Fund Managers. These funds invest in local currencies in accordance with world stock market weightings. This means, for example, that around 46% of global equities are quoted on US stock markets. Hence, our Dimensional equity portfolios hold 46% US quoted equities denominated in US dollars. It is important to recognise the importance of where a share is quoted does not necessarily have a bearing on where it trades. For example, Google is quoted in the US but trades around the globe.
Fixed interest investments are a little different. With our Dimensional portfolios the only purpose of fixed interest investments is to remove some of the volatility of the overall portfolio which can only be caused by the equity content of that portfolio.
Hence, all our Dimensional fixed interest investments are made in short dated investment grade fixed interest. Short dated refers to the time remaining before the bond or gilt in the portfolio matures and so is redeemed. The average duration at the moment is always under 5 years and at present is around 3.5 years.
Holding such short dated fixed interest investments removes much of the inflation risk associated with fixed interest. The longer the investment has to go to be redeemed the more volatile it will be. This is because it pays a fixed amount, or coupon, based on its original nominal value. So as inflation and thus interest rates rise then the capital value of the long dated bond or gilt will fall to compensate. Hence the shorter the date to maturity the less volatile it is.
The geographical spread of fixed interest investments is global but in the case of fixed interest, Dimensional hedge the investment in the foreign currency back to UK pounds. If they did not do this the fixed interest element of the portfolio would be volatile simply due to currency fluctuations.
If you are holding our globally diversified Dimensional funds you are doing as much as you can to avoid the volatility caused by the UK pound depreciating or depreciating against other currencies.
If you would like further information on our investment philosophy call Andy Parker on 0121 704 1354 or email us here.
IFA and Chartered Financial Planner Birmingham