Does frantic forex threaten your portfolio?
Søren Otto Simonsen
Senior Investment Editor
Summary: Throughout this year - and mainly since summer, strong movements within the Japanese Yen, the British Pound and the US Dollar have been very much in focus. Such movements have major implications for macroeconomics and politics, global businesses and professional traders, but do they matter to your portfolio? We have asked our Head of FX Strategy, John J. Hardy just that.
You may have noticed that currencies such as the US Dollar, the Japanese Yen and the British Pound have been a big part of the news cycle in 2022. But many don’t trade currencies – otherwise referred to as forex, leaving the question whether such movements matter for private investors? To investigate that, we have spoken to our Head of FX Strategy, John Hardy.
“Virtually all major currencies have seen major swings over the last year and more, showing that you need to stay vigilant on the impact of forex moves on your investments,” he says.
“Depending on your portfolio construction, the volatility on the currency markets may have a smaller or larger impact on your returns. If you for instance invest in a service company in your home country that only operates there and has no import costs of note, you may not have to consider the currency angle at all. But if you invest in multi-national companies, you’ll need to pay attention to currency risks as a factor and consider hedging. At the extreme, if you invest in a company or bond from an emerging market country, you can actually end in a situation where your investment’s performance is affected equally or more by the country’s volatile currency than The extent of these moves, comes down to how your portfolio is set up, according to Hardy:the underlying performance of that instrument in local currency terms,” he says.
he says.“It’s important to understand how forex impacts a company’s profits. Right now, the major driver of forex volatility has been the aggravated rise in the US Dollar as the US Federal Reserve tightening policy viciously to get ahead of inflation. This means that US companies with high levels of international sales take a hit from those revenues translated into US dollars, while non-US companies with significant sales in the US enjoy a profit tailwind and competitive advantage.”The impact of forex movements depends on both the currency market and also on the companies you are investing in:
Hardy says. “It is most critical to consider how the stocks and bonds in your portfolio might be affected by extreme forex movements, like this current strong USD movement, impact the fortune of the companies you invest in,” In a situation where forex movements get extreme they tend to have a greater impact on financial instruments and the economy in general, rendering the notion of being aware of how currencies impact your portfolio even greater.
What to do, then.
Hardy says.“Uncovering forex risk should be part of your company research before you decide to buy a stock. You should look at where the country is based, whether it gets it’s profits from a market with local currency or another currency and is there anything you should be aware of based on that. You should also consider the company’s value chain: Is it e.g. exposed to paying producers in other currencies and is that something to be aware of?,” To ensure that you are aware of how such affects will hit your portfolio, you need to put in the work:
he says. “In forex markets, there’s always a winner and a loser. One currency becomes stronger when another weakens. If you want to protect your portfolio from this, you can use a variety of derivates like options to do what is called a hedge. This essentially means that you try to remove some unwanted risk from your portfolio. But be aware, this is a complex process, so before you engage in hedging, make sure you understand the concept fully,” If some unwanted forex risk arises in your portfolio, Hardy explains that there are ways to go about it:
When global uncertainty rages, investors may feel like the entire notion of forex is an inconvenient truth. But on a larger scale, the currency market would be hard to live without.
“The forex market is tremendously important for the global financial system. Exchange rates are essential for cross-border interactions, and a very important consideration, both strategically for sovereign powers and for businesses that source and sell goods in currency regions other than their own.” Hardy says.
At the same time, the forex market is the largest of all financial markets in terms of volumes, and it is also the only one that is open 24/5. Money do, in fact, make the world go around – but are you aware of how it impacts your portfolio?
If you want to read more about how to trade forex and what kind of products are available, check out our theme “Around the world in 7 pairs”. If you want to stay updated on the markets and how they develop, find Hardy’s FX updates here. If you want to learn more about hedging and how it works, click here.
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