Markets are like complex ecosystems.
Multiple variables are linked via a dense web of interdependencies.
One complex factor with a huge bearing on global asset prices is currency movements.
Big changes in the value of sterling over the past year or two have illustrated the importance of currency effects and the value of factoring this into portfolio construction.
We examine currency effects closely and they are an important factor to consider when assessing the merit of a wide array of regions and asset classes.
Here, we look at how currency effects can impact on UK assets; the impact on holders of foreign currency assets; and the potential benefits and risks this poses; as well as reviewing how investors might respond to currency risk.
Sterling since 2016
Currencies trade everyday on global financial markets in huge volumes and their relative value to one another can shift significantly over time.
Investors buying assets in a foreign currency can find those changes create a distorting effect which influences the value of their portfolio more than the intrinsic value of the underlying assets.
Starting close to home, sterling experienced a sustained spell of weakness following the EU referendum in June 2016, and the decline in the value of the pound in 2018 alone was particularly marked.
In 2016, when the UK public went to the polls to vote on the UK’s future relationship with Europe, the pound was worth around $1.40 to $1.45. Over the past few months it has traded between $1.25 to $1.34.
That is a significant drop in a relatively short period of time.
In the months shortly after the vote, sterling experienced a lengthy sell-off and although it did stage a recovery in early 2018, it has since become notably sensitive to rhetoric around the Brexit outcome.
As politicians in Europe and the UK have speculated about the possible outcome, and the UK government jostles with competing interests to try and get a deal over the line, the value of the pound has correspondingly fallen and risen in line with the market’s level of concern about the possibility of a disorderly or no-deal Brexit.
That has a significant bearing on UK-listed equities. Domestically-focused companies selling goods in pounds but importing materials from overseas may suffer, for example.
This is because their cost of acquiring materials abroad goes up, but this is not counteracted by a similar effect in foreign earnings if they only sell to domestic clients.
In contrast, however, international firms deriving sales from overseas jurisdictions are likely to benefit from a weaker pound. And this is where things may begin to become counterintuitive to some clients - how can a fall in the value of the pound benefit a UK-listed business?