Investing overseas can mean exposing yourself to dangerous currency risk.
Until recently, I never much worried about currency exposure when choosing where in the world to invest.
The pound was steady, and had been strong for some time, and I assumed that any dips or swings in its value would even out over time. But then it shed 30% of its value in the credit crunch, and I began to find the question of currency rather more interesting.
And even though sterling is clawing back some of its lost value, particularly against the US dollar, I still do because recent volatile currency fluctuations have opened up a new world of investor worry.
I'm clearly not alone in being concerned. Sarasin Partners believes the threat is sufficient to launch two new global equity funds, to shelter sterling-based investors from wider movements in exchange rates.
Keep abreast of currency affairs
Currency exposure cuts both ways. If you invest in a US company and sterling rises against the dollar, the value of your income or capital growth will shrink once you convert it into pounds. But if the pound weakens, the value of your dollar earnings will increase, giving you more bang for your buck.
The crumbling pound has hit the value of any investments you hold in dollars, euros and other currencies, although that is now reversing slightly. But it is important to remember that the moment you exposure yourself to foreign currency you are taking a bigger risk than investing in the UK. And potentially more costly, because your bank may charge a fee to convert any dividends you repatriate into your UK account.
Play the game
Some investors try to turn currency exposure to their advantage, by investing in a weaker currency, hoping to benefit when it bounces back.
If you think the dollar has been oversold, you might be tempted into a stock or fund invested in the US. Or if you fear the economic problems afflicting Ireland, Spain, Italy, Greece and Portugal could scupper the euro, you might want to sell some of your European investments to limit the danger.
But this is also a dangerous game. Second-guessing exchange rates is as impossible as timing stock markets.
Currency movements in recent months have been rapid and unpredictable. Until recently, British shoppers flooded into the US to celebrate the fact that every £1 they spent bought them $2 worth of goodies. By January, it bought just $1.36, and shopping trips across the pond lost their lustre.
How much!
Investors have far more at stake than the price of a pair of jeans. Once you start dealing in larger sums, even small shifts in the exchange rate can have a big impact on your returns.
Say you invested £20,000 invested in a US share or fund when £1 was worth $1.40. A subsequent rise to $1.60 would have shrunk your holdings by £2,500 without any stock movement at all. Yet many investors never take this massive risk into account.
Arm yourself
A few weeks ago, I bought shares in ARM Holdings (LSE: ARM), the semiconductor intellectual property supplier. Based in Cambridge, it earns 90% of its revenues in dollars.
I took an immediate and unexpected 12% hit, and I suspect the slide in the greenback was partly behind that. Now this is designed as a long-term hold, so I can get over that, but it was still a disappointment and one I hadn't prepared myself for.
Currency risk is a key element to consider when planning your portfolio, so make sure you know what you are exposing yourself to.
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