To avoid ‘putting all our eggs in one basket’, multi-asset portfolios are diversified across a range of markets and asset classes.
Our client portfolios own stocks and shares traded in a variety of different countries. This means that a Sterling-based portfolio becomes exposed to foreign currencies too – as you would expect, US shares trade in US Dollars and German shares in Euros.
As at January 2018, the split of currencies in the equity holdings in the Trivium* portfolios with 50-100% equity looked like this (portfolios with less than 50% equity have a similar profile without Emerging Markets):
This creates the risk that the value of the portfolio to a UK investor changes when the value of Sterling changes, regardless of what happens to the underlying investments.
Currency movements are typically driven by economic and geopolitical factors and they can be volatile. For example, in 2016 the UK’s referendum decision to leave the EU caused a sharp and extraordinary weakening of Sterling against most major currencies. This is known as currency risk. If the Sterling exchange rate gets stronger, the value of overseas assets falls; if Sterling weakens, the value of overseas assets increases (just as the price of a drink on a foreign holiday goes up or down when converted back to Sterling).
The chart below shows the exchange rate of Sterling versus the US Dollar over the 5 years to February 2018.
The peak over this period was 1.71 in June 2014 and the trough 1.22 in March 2017 – a difference of 41%. This created significant gains for UK investors for a few years as the 40% depreciation of the value of Sterling boosted the value of US investments over the short term.
Some of this positive impact has since reversed. The Sterling recovery over the last year or so has detracted from portfolio values. Over the long term, we expect that the impact of currency fluctuations on the value of the portfolio will be minimal, as exchange rates move around a long-term average (mean reversion).
As always, we remind you of our core belief that discipline protects investors. Taking a long-term investment strategy based on lifetime goals enables investors to ignore market noise surrounding events such as these, reassured in the knowledge that short-term market volatility will not impact their long-term outcome.
*Trivium is the investment group that Plan 100 belongs to.