Since the Brexit vote in June last year the pound has fallen sharply and is currently down 12 per cent on the dollar since this time last year, meaning British investors have seen their overseas assets increase in value.
UK companies with earnings overseas also benefited from sterling’s weakness, with the FTSE 100 index rallying to record highs.
Yet Frank Spiteri, head of distribution at ETF Securities, warned many investors neglect the impact of currency on markets.
Despite currency movements being a huge contributor to overall returns, he said investors still tend to devote a “disproportionate focus” on the underlying asset, overlooking the impact of currency on foreign allocations.
He pointed out, for example, that any investment denominated in a currency other than an investor’s own exposes them to risks emanating from currency fluctuations, as well as movements in the asset itself.
Gold, for example, is dollar-denominated, which means British investors exposed to this asset class could benefit from the pound falling against the dollar.
This risk is often overlooked because of the mistaken belief that investing in a foreign investment, through a sterling share class, protects clients from currency risk Ben RavenMr Spiteri said: “In the past, currency market volatility has peaked and troughed around market events, but since the start of 2015 it has remained persistently elevated.”
This, he said, has arisen primarily as a result of unprecedented and unconventional intervention by the central banks, which has caused some of the most pronounced moves in exchange rates on record.
“This landscape is novel and has massively raised the importance of monitoring currency exposure, something that has typically been a secondary consideration.”
The ETF Securities head warned that failing to effectively manage currency can cause the investment profile of an asset to deviate from expectations as exchange rate moves impact performance.
Ben Raven, who is responsible for business development at Tavistock Wealth and an expert in currency hedging, highlighted why currency risk could end up being the next scandal in the financial services industry.
He pointed out that in recent years advisers have shifted from recommending UK-centric portfolios to a globally diversified approach, which means the average retail client now has exposure to the currency markets.
“This risk is often overlooked because of the mistaken belief that investing in a foreign investment, through a sterling share class, protects clients from currency risk.
“However, any unhedged investment denominated in a foreign currency, exposes clients to movements in the underlying asset and the relevant currency pair.”
Mr Raven questioned whether advisers know what proportion of portfolio returns have resulted from currency market movements over the past 10 years, rather than asset class performance.
He also questioned whether clients are being made sufficiently aware of this risk.
Rules set out by the Financial Conduct Authority demand that portfolios reflect the risk appetite of customers, but Tavistock's business development boss said clients are often exposed to a risk that they did not sign up for, and which could result in their portfolio becoming misaligned with their agreed risk profile.
Mr Raven added: “Many advisers would agree that investment in a currency fund would be inappropriate for most clients. However, recommending global portfolios with unhedged overseas exposure appears to be a regular occurrence.”
Scott Gallacher, director and chartered financial planner at Rowley Turton, said: “If investors have strong feelings then they could position their portfolios one way or another to avoid or benefit from the currency movements.
“Alternatively they could consider hedging the currency risk within their investments or investing in those funds which already hedge the currency risk.”
But he pointed out that hedging may simply add another risk to investors because the underlying investments tend to be multinational companies which may, or may not, have already undertaken hedging on their own activities.
Mr Gallacher therefore said investors might end up compounding the problem.
“I prefer to take a more balanced approach, investing in a range of assets across the whole world. This avoids having all your eggs in one basket.
