What your clients need to know about currency exposure

  • Identify how currency effects can impact UK assets.
  • List the benefits and risks posed by holding foreign currency assets.
  • Describe how clients might respond to currency risk in their portfolios.

The primary reason is the simple currency conversion boost they receive on overseas earnings.

A UK-listed company selling goods in the US, for instance, needed to make sales of approximately $14.5m to make £10m of revenues in the summer of 2016.

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Today, it only needs to generate around $12.5m of sales in the US to generate the exact same revenue in sterling terms.

Just for being listed in the UK, the firm can, in effect, suffer a 15 per cent drop in sales and stand still in equivalent terms once the revenues are translated back into its domestic currency.

So even if the company is struggling to grow sales, currency effects may protect its reported profits. 

This is a particularly important concept for investors in UK assets. Many may be concerned about UK assets due to Brexit uncertainty.

But around three quarters of FTSE 100 company revenues are earned abroad, meaning shares in those companies are highly influenced by currency effects. In fact, the UK stock index has been a net beneficiary from a weakening in the value of sterling since the referendum. 

Currency effects in 2018

UK investors holding US assets in 2018 present a useful case study in the effects of currency moves.

A strong end to 2017 and positive earnings reports in 2018 led to share price appreciations, with the big technology companies leading the way. 

But a turn in fortunes saw the US index give up many of those gains. Despite a summer high, the index slumped rapidly and shrank back such that by the mid-autumn it had given up those gains for the year.

By the close of the year it had fallen circa 5 per cent over 2018 start to finish. 

For UK-domiciled holders, however, currency effects mean the impact was not felt as sharply.

The relationship between sterling and the US dollar insulated investors from the slowdown in US stock prices to some extent. 

The following chart illustrates how. The white line on the chart shows the S&P index in dollar terms, while the orange line plots it in sterling.

Source: Bloomberg and Quilter

The currency translation effects are startling. In dollar terms, the negative total return is -5 per cent, while share prices fell 7 per cent.

In contrast, the sterling investor enjoyed a modest total return of a little over 1 per cent.

But the story evolved over the course of the year. As the chart shows, the investment journey for sterling-denominated investors looked very different from that experienced by domestic investors. 

In the first quarter, sterling rallied against the dollar, breaching $1.40 to the pound in April. That is reflected in the chart above, with sterling-denominated investors lagging in the early part of the year.

As 2018 progressed and Brexit-fuelled concerns took hold, the pound fell sharply against the dollar.