A rewarding FX strategy for equity investors

Currency timing may pound your portfolio

What should UK investors do about the swinging pound? While currencies don’t drive stocks, they do impact your returns on foreign investments, making hedging a hot topic as sterling gyrates. My advice: Think long-term, and fight the urge to time this.

Stocks and currencies have no set relationship. Since the dollar started trading freely in 1973, the correlation coefficient between the trade-weighted US dollar and S&P 500 is -0.15 – basically meaningless. When the dollar and stocks move together or opposite, it is coincidence. Same goes for the pound and UK stocks.

Yet currency moves do influence portfolio performance if you own stocks outside Britain. When the pound is weak, it boosts your foreign returns. You get the stock’s actual return, plus the appreciation in the dollar/euro/yen/whatever. When the pound is strong, it subtracts from foreign returns.

After last year’s Brexit vote, the weak pound was a boon for globally invested Brits. From June 23 through year-end, world stocks soared 25.2% in pounds. In local currencies, it gained 8.4%. This year, sterling is more of a headwind. Through to the end of August, global markets are up 7.4% in pounds versus 8.7% in local.

Currency swings bring out investors’ worst market-timing impulses. Last year, no one wanted to hedge or go all-UK. This year, hedging is hot.

Don’t get sucked in. I’m agnostic on hedging. Do it if you think it will help reduce short-term volatility, or don’t. But whichever you’ve chosen, stick with it. Currencies can reverse fast. After all, entering 2017, most Brits with global exposure feared the pound reversing last year’s weakness would water down returns. While the pound has strengthened a touch year-to-date, it weakened over the last six weeks. Not what you’d want to hedge against!

Forecasting currency swings is tough. I don’t know anyone who nails it repeatedly. Currencies trade in pairs and they are heavily influenced by relative interest rates. Currency investors can move money across borders easily and often target higher expected interest rates. So, to forecast the pound’s broad movements, you don’t just need to forecast UK interest rates. You’d also need a good read on expected rates in America, the eurozone, Switzerland, Japan and more.

Then, too, central bankers influence interest rates – they’re wholly unpredictable. How many times has Mario Draghi said one thing and done another? Janet Yellen? BoE chief Mark Carney waffles so much an MP dubbed him Britain’s “unreliable boyfriend.” Do you want to base your portfolio strategy on such flip-floppers?

Instead, think longer term. Over time, currencies’ ups and downs even out. Consider this bull. Since its 9 March 2009 birth, global stocks in sterling are up 259%, 237% in dollars, 231% in local currencies. All pretty close! If you’re patient enough, currency swings’ impact should be minimal. Conversely, trying to time currency moves is often a path to the poorhouse. It’s shortsighted and harmful – like trying to skirt short-term volatility.

None of this is a viable reason to ditch a global approach. The lack of diversity in an all-UK portfolio adds big-time risk. If you’re all UK, diversify now. And if you’re invested globally, stay the course. If you’re hedged, stay hedged. If you’re unhedged, stay unhedged. Overweight UK and eurozone stocks to benefit from magical falling uncertainty, but put money in America and Asia, too. Firms there are growing and profitable. They’ll reward your patience. Here are two:

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This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.