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. 

The astonishing, phoenix-like rise in US shares that’s been underway since late October has taken America’s leading market index – the S&P 500 – to within a whisker of its record high in 2021. The market’s latest move looked little more than an outside bet just over a month ago, when the S&P 500 was languishing around 12% lower. But a lot has changed since then.

US inflation has been falling into line and with it expectations about interest rates. Markets have gotten ahead of official central bank guidance and are now beginning to savour the prospect of rates starting to fall, perhaps as early as during the first half of next year. That implies an improved outlook not only for shares but also for bonds, to which shares are routinely compared for valuation.

The problem for non-US investors is that moderating interest rate expectations is bad news for the US dollar. The Bloomberg Dollar Spot Index – which measures the present value of the dollar versus a basket of ten other leading global currencies – has fallen by 2.6% since the S&P 500 bottomed on 27 October1.

For UK investors the effects have been worse. The dollar has fallen by 3.5% against the pound over the same period, further diluting returns from the US2.

If all this sounds a bit too short term for you, you’re probably on the right lines. The truth is stock markets and currencies can record some eye-watering moves over short time frames that invariably become far less meaningful over the longer term. The pound-dollar rate is, for instance, more or less where it was five years ago, at 1.25 dollars to the pound3.

Source: Investing.com from 13.12.18 to 13.12.23.

Even so, such contrary moves between a stock market and its currency as we have seen recently still begs the question as to whether investors ought to consider a strategy that hedges out currency risk.

Generally speaking, actively managed investment funds are unhedged against currency movements. This is sensible, given that currency moves are hard to predict and hedging entails an ongoing cost to investors with no guarantee of adding value.

It’s important to remember too that the performances of the underlying companies that a fund holds are also affected by currency movements.

Exporters benefit from a weak home currency that makes their products and services more internationally competitive. On the other hand, businesses importing goods from overseas to sell to their customers at home see an uplift from a strong home currency. Hedging out all of these upside and downside risks would not be a realistic prospect.

These considerations are worth bearing in mind in the context of investing in the UK. Avoiding overseas markets certainly doesn’t mean avoiding currency risk. At the last count, 82% of the revenues of FTSE 100 companies were earned in foreign currencies. Even more surprising, perhaps, is that around 57% of the earnings of FTSE 250 businesses also come from abroad4.

One of the consequences of this is that UK investors have the opportunity to allocate some of their money overseas, with only a limited increase in effective currency risk compared to investing in the UK alone.

Some sterling bond funds that invest globally do hedge. They see hedging currency risks as removing one impediment to maintaining a stable income for their investors. Hedging can also add to a bond fund’s stabilising capability when held in a diversified asset portfolio.

A perennial best seller at Fidelity Personal Investing – the Fidelity Index World Fund – tracks the MSCI World Index converted back into sterling. It has an ongoing charge of just 0.12%, so offers an attractive way of diversifying an investment portfolio composed mainly of UK funds or shares without taking on additional (direct) currency risk.

However, these examples are much closer to being the exception than the rule. For most investors the sensible approach is to manage rather than defeat currency risk. By holding a portfolio of investments diversified by geography, the effects of a significant move of an individual currency is soon watered down. Time often performs a similar task.

Source: 

1,2,3 Bloomberg, 12.12.23

4 FTSE Russell, 18.10.22 

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. 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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