Tuesday 2 October 2012

Impact of currency on overseas fund?

Question
I understand how currency swings can affect investments but I'm struggling to identify exactly which currencies I am exposing myself to.

For example, if a fund invests in a basket of Latin American stocks but the fund manager I buy from is based in the U.S., am I exposed to swings in the US Dollar against the Pound, a range of Latin American currencies against the Pound or a combination of both?Answer
Ultimately, the answer is with great difficulty. Even a UK FTSE All Share tracker can be affected by currency movements in so far as the many of the underlying companies have exposure to currency via exports or overseas operations.

But let's looks at the bigger picture which I think is what you're asking about. Here are a couple of examples.

Suppose you buy units in a US fund that invests in the UK stock market. You convert your pounds into dollars, which the manager converts back into pounds to invest. When selling units the manager receives pounds which are converted into dollars which you then convert back into pounds. Sounds confusing, but the bottom line is exchange rate movements don't really impact your fund value in this instance. You invest £1,000 at £1 = $2, i.e. $2,000 of units. The manager buys £1,000 of UK shares with the money. Suppose the exchange rate moves to £1=$1.5 then selling the shares gives $1,500 which is worth £1,000 when you convert back into pounds.

So buying a fund in another currency that invests in assets priced in your home currency is unaffected by movements in those two currencies (ignoring the underlying investments themselves, which may or may not be affected by currency movements as mentioned at the beginning of my answer)..

Let's now assume you buy a US fund that invests in European shares priced in euros. You invest £1,000 at £1 = $2 to give $2,000 of units which buys €1,500 of shares at $1 = €0.75. The manager sells the shares at $1 = €0.5 to give $3,000 which is converted into £2,000 at £1 = $1.5. So you've doubled your money because of currency movements.

Breaking this down, the dollar/euro movement increases value by 50% and the dollar/pound by a third, but as the dollar/pound movement applies to the 50% increased dollar amount (due to dollar/euro movement) the overall impact is actually two thirds (50% x 1.333).

Anyway, the bottom line is that both sets of currency movements have affected the fund's value without any change in the underlying share prices. So in your example you'd be exposed to movements in all three currencies.

Read this Q and A at http://www.candidmoney.com/questions/question751.aspx

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