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Sunday 11 December 2016

Why currency wars cost you money

Now might be the time to stock up on the greenback - but it's risky territory, writes Louise McBride

Published 27/09/2015 | 02:30

Currency wars - where countries deliberately try to depreciate the value of their local currency so they can stimulate their economy - have become a major concern for investors.

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They've knocked billions off the value of pension funds, sent stock markets plunging, and made overseas property prohibitively expensive for some people - and dirt cheap for others.

"Currency wars are a live issue for investors," said Jason Hollands, managing director of the British investment broker, Tilney Bestinvest.

"You could be investing in a region and enjoying strong returns on the stock market - but if the currency is moving the wrong way, you'll lose some of those returns. If a country seeks to revalue its currency, it's always at someone else's expense."

There has been a string of currency wars of late - and there could be more to come.

Last month's move by the Chinese government to devalue the yuan was China's biggest currency intervention in more than two decades.

Japan has driven down the value of the yen through quantitative easing - the term used to describe a central bank's decision to print money. The European Central Bank did the same thing to the euro earlier this year.

"Japan is nowhere near its inflation target and it may have to print more money," said Mr Hollands. "It's the same in Europe. So you might expect continued weakening in the euro and yen."

One way to protect yourself from swings in foreign exchange is to invest in funds which offer currency-hedged share classes. These funds try to reduce the impact of exchange rate movements on an investor's return. They do so by converting any investment return back into the preferred currency of an investor - if that fund has exposure to a currency which is weak or different to an investor's favoured one.

For example, let's say you're an investor based in Ireland who believes the US dollar will perform strongly over the next few years. You want to increase your exposure to the dollar through an equity fund. To do that, you could choose a version of the fund which translates your investment returns into dollars.

Your investment returns could be 20pc higher if opting for a hedged fund over an unhedged one - as long as you hedge the right way and the currency you favour doesn't go against you. (It's also important, of course, that you choose an investment fund which performs well).

The Artemis European Opportunities Fund is one fund that allows you to hedge your bets against falling currencies. The traditional version of that fund is unhedged, so you invest in EU stocks - and get your return in euro. In the three years to the end of August 2015, the unhedged version of the fund made a return of 49pc, according to Mr Hollands.

"In contrast, the sterling-hedged version made a return of 59pc over three years by stripping out the euro exposure," said Mr Hollands. "The fund's porfolio - that is the companies that it invests in - is exactly the same for the hedged version as the unhedged one. The extra return comes from the fact that you haven't been exposed to the euro."

With the recent devaluation of the Japanese yen, a number of Japanese equity funds offer hedged versions of themselves. One such fund is the GLG Japan CoreAlpha Equity Fund.

"If you bought that fund three years ago, the euro-hedged version would have made you a return of 126pc since then," said Mr Hollands. "Had you bought the sterling-hedged version, your return would have been 145pc. But if you bought the US-hedged version, you would have made a 151pc return.

"Again, in each case, the companies you have invested in through this fund are exactly the same."

Not all funds allow you to hedge your bets against different currencies. However, the demand for such funds has increased, according to Mr Hollands. "They are not widely available but more of them have started to emerge in recent years - because of the aggressive measures taken by central banks to print money," said Mr Hollands.

But Mark Dampier, head of research at the British investment firm Hargreaves Lansdown, urges caution on currency-hedged funds.

"My view is that if you invest overseas, you take the currency risk," said Mr Dampier. "When fund managers start trying to do clever things with currency, most make a total hash of it.

"Over time, I think the currency question self-corrects within the market anyway - that is, the companies within the market make up for any currency fall. Also, in the age of globalisation, many companies hedge, so you may end up with an opposite effect to the one you wanted."

The weak euro has also made it more expensive for Irish people to buy property in Britain and the United States.

"The euro has weakened over the last nine months and as a result it has become more expensive for Irish people to buy property in the likes of London," said Bryan McSharry, managing director of MoneyCorp, a Dublin corporate foreign-exchange specialist.

"Irish people were more likely to make overseas investments when the euro was stronger. No one knows where the euro will be in the future."

Predicting currency movements is risky. Taking a historical view could be a good approach - but even this could catch you out, particularly if you're not investing for the long term.

G10 currencies tend to be less volatile historically, while emerging market currencies tend to be more volatile, according to Pat McCormack, head of Barclays Wealth in Ireland. G10 currencies include the euro and yen, which are weak at the moment, as well as the US dollar, British sterling, Norwegian krone and Swiss franc.

"Many commodity-linked currencies - such as the Australian and Canadian dollars, the Indonesian rupiah, the Malaysian ringgit, the South African rand and the Brazilian real - are doing badly due to the sharp fall in commodity prices from last year," said Mr McCormack.

"The euro and Japanese yen have also underperformed due to greater monetary accommodation. The main outperforming currencies this year are the US dollar and British sterling, owing primarily to relatively strong economic fundamentals, as well as prospects of interest rate hikes."

The US Federal Reserve, didn't raise interest rates earlier this month - but some investment experts expect it to do so before the end of the year.

"It appears to be on a path where it wants to start normalising monetary policy," said Mr Hollands. "So the US dollar is one currency which may be more likely to be strong. Likewise, rates are likely to go up in Britain. That would probably be followed by a stronger currency."

The dollar, however, might not be as strong as people expect, warns Tom Stevenson, investment director with the British investment broker, Fidelity Personal Investing.

"If US interest rates stay lower for longer - as now looks likely - it is entirely possible that dollar weakness could ensue as investors re-adjust their views," said Mr Stevenson.

"Some of the weakest currencies recently have been commodity-exposed emerging markets. The consensus is that this will persist, but the sharp falls in the likes of the Indonesian rupiah, South African rand and so on could mean that the bad news is already in the price.

"Exchange rates matter to investors but are notoriously difficult to predict. My view is that exchange rates come out in the wash over time - and that personal investors are better off focusing on investing in the right geographies, sectors and companies, rather than spending too much time trying to second-guess currency moves."

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