Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest

CONFINING our thoughts to home shores, you could be forgiven for thinking the pound ought to be performing well. This week, we learnt that unemployment is now at its lowest in 48 years and the average UK house price has soared to £278,0001.

For an economy more than two thirds driven by consumer spending, both events should be a good thing. Low levels of job insecurity and high house prices are supposed to lift consumer confidence and spending because both make us feel more secure and wealthier.

The pandemic is now broadly in the rear view mirror, opening up a whole new range of spending possibilities. The rapidly rising prices of holidays, used cars and collectables might suggest many of us have returned to our old buy-now-pay-later ways.

That’s all well and good. However, there are two sides to every coin and on the other side of this one are the war in Ukraine, soaring food and energy bills and rising interest rates. These are not reasons to be splashing out on goods and services we don’t really need.

The jury’s still out. UK retail sales climbed 1.4% in April, but only after declines of 1.2% in March and a 0.5% fall in February2.

On the international currency markets, the predominant consideration has not been how well or otherwise the UK has been faring. The attractions of the dollar have been king.

Despite the rise of China, maturing of the euro as a major world currency and advent of crypto challengers like bitcoin, the dollar remains the world’s number one reserve currency by a country mile.

That’s especially important when the world is in a state of high economic uncertainty, some might say, confusion. Meanwhile, US interest rates are anticipated to rise by at least as much as UK rates over the next year, and very probably by more. That again adds to the relative attractions of the dollar.

The pound is now worth fewer dollars than at any time since July 2020. It’s also knocking on the door of levels last seen in the mid 1980s3.

As investors, we need to think about the effects of a weak pound in two ways: from the point of view of the investments we already own; then investments we would like to own.

Simplified, a weak pound is great news for UK investors with existing holdings in overseas markets. They will have seen the value of their investments boosted by a weak pound.

Moreover, the fact that the dollar has conversely been so strong will have helped investors with portfolios broadly aligned to world stock market indices. At the end of last month, US shares accounted for 68% of the MSCI World Index4.

As ever, there is a price to pay. Future investments in world markets will be more expensive. This may be of concern to people still with cash to invest or those saving regularly into global markets.

Having said that, the powerful benefits of regular saving – many of which come through automatically buying more when prices are low – should never be underestimated and, it could be argued, significantly outweigh currency considerations.

Contrastingly, it stands to reason that investors with predominantly UK-based portfolios will have been adversely impacted by a weak pound, but not so fast. And this is where the picture becomes a bit more complicated.

In the UK today, many companies earn a good deal of their income from sales in foreign markets. It’s estimated that more than three quarters of the earnings of FTSE 100 companies emanate from overseas, while around half of the earnings of FTSE 250 businesses also do5.

In which case, UK equity investors, apart perhaps from some of those with large holdings in smaller companies, will also have benefited from the pound’s weakness. Remember, a weak pound raises the value of overseas revenues in sterling terms.

But there’s another factor to consider too, which has been growing in importance over recent months owing to sharp rises in commodity prices. This other factor is the effect of a weak currency on the costs going into companies.

The war in Ukraine has heaped further upward pressure on food and energy prices, which were already moving higher following Brexit and the pandemic.

So another divide has opened up – made more intense by a weak pound – between the beneficiaries of rising inflation such as miners and energy companies and the losers in this environment, mainly the makers and retailers of non-vital goods and services being forced to absorb rising costs.

Taking one obvious example – fuel prices – helps illustrate just how damaging a weak pound can be. The last time the dollar cost of oil was as high as it is today was in 2008, when the pound – currently worth around $1.25 – was, at least for some of the time, trading around the $2 mark6.

Today’s energy crunch is therefore significantly more damaging than the one we saw 14 years ago.

According to Ernst & Young, 72 UK listed companies issued profit warnings in the first quarter, and 43% of these warnings were down to rising costs. Unsurprisingly perhaps, the largest number of warnings came from consumer facing sectors7.

The upshot of these effects is that a stay-at-home investment strategy cannot be relied upon to insulate an investor from the upside and downside risks caused by a weak pound. There is no truly safe place to hide.

Theoretically, it is possible to insure an investment portfolio against currency movements through “hedging”, but to do so can be a complex and costly affair.

Most of the time though, diversification is the real key. Currencies move around against each other over time in a largely unpredictable way that is costly to hedge against, so the best an investor can normally do is spread their investments across many of them.

The Fidelity Select 50 Balanced Fund shows the way. This fund invests in 30 or so other funds, mostly taken from Fidelity’s Select 50 list of favourite funds. Alongside a 33% weighting in the UK, this fund currently has large positions in Europe (17%) the US (31%) Asia (6%) Japan (7%) and smaller holdings of one or two percent in Australasia, Canada and Africa. It is unhedged against currency movements.

1 ONS, 18.05.22
2 ONS, 20.05.22
3 Bloomberg, 19.05.22
4 MSCI, 29.04.22
5 FTSE Russell, May 2017
6, 19.05.22
7 EY, 03.05.22

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. The Fidelity Select 50 Balanced Fund invests in overseas markets and so the value of investments can be affected by changes in currency exchange rates. This fund uses financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Currency hedging is used to substantially reduce the risk of losses from unfavourable exchange rate movements on holdings in currencies that differ from the dealing currency. Hedging also has the effect of limiting the potential for currency gains to be made. The Fidelity Select 50 Balanced fund investment policy means it invests mainly in units in collective investment schemes. There are just a few fixed limits for the three core elements in the fund. These are 30% to 70% for shares, 20% to 60% for bonds and 0% to 20% for cash. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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