Managing Currency Risk
Investors living and spending abroad will quickly recognize their exposure to currency risk: the incongruity between foreign currency denominated “expenses” and “dollar” denominated investments. A well-diversified portfolio not only mitigates overall investment risk but also limits currency risk. This involves diversifying the portfolio’s underlying income away from purely U.S. sources. European, Asian and emerging market stocks, non-U.S. bonds and gold are all distinctly uncorrelated to the U.S. dollar and its fate.
A common misunderstanding of cross-border investors is to confuse the currency used to measure an investment value with the underlying currency exposure of that investment. For example, the stock of a British company such as Glaxo Smith Kline will be listed in both London and New York. If we buy a share in New York and hold it through U.S. broker, its value will be reflected on a U.S. brokerage statement in U.S. dollars. The same investment, bought through a British broker in London, will have its value reported daily in pounds. Shares of GSK traded in New York are exactly the same as shares of GSK in London. The difference between the value of the shares measured in dollars or euros reflects the changing U.S. dollar/euro exchange rate. In other words, the value of the investment in the Glaxo shares remains exactly the same, whether purchased in London or New York, and whether calculated in dollars or pounds.
The Glaxo example above refers to stocks. However, for investments in “cash,” currency does matter. This is because the relative value of one currency holding will rise or decline as currency values adjust and change over time.
For a portfolio of securities held for long-term investment, cash positions should be limited. Cash, held in any currency, loses “real” or purchasing value by appreciating at a rate lower than inflation over time. Consequently, a well-designed portfolio strategy held for long-term investment should only hold assets that appreciate at a rate above inflation: stocks, bonds, commodities, REITs. These assets will build real wealth over time; and by, contrast, holding large amounts of cash will destroy wealth over time.
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