How does currency impact investment returns?

Diversification has been called the only free lunch in investing. Beyond diversifying across asset classes and sectors, geographic diversification is also important when it comes to managing investment risk and getting better returns. While investing beyond Hong Kong’s borders has its advantages, fluctuations in exchange rates can affect your portfolio – especially in the short term.

What does this mean for your portfolio, especially if you have investments outside of Hong Kong? Geographic diversification is no-doubt important when it comes to managing investment risk and getting better returns. While Hong Kong Dollars are pegged with United States Dollars; investing beyond Hong Kong’s borders still faces fluctuations in exchange rates that can affect your portfolio – for better or for worse.

Why exchange rates fluctuate

Currencies are always fluctuating in price against one another as they are traded on the foreign exchange (forex) market. We will take GBP as the case study below. A currency’s forex value depends on a confluence of factors, including:

Central bank interest rates. The higher the interest rates paid by a country’s central bank, the more valuable the currency becomes. This attracts more foreign capital as investors will get a better return by holding assets in the country’s currency. The currency thus increases in value i.e. appreciates due to the rise in demand. 

Economic growth. A country with strong economic growth and financial stability is more likely to attract foreign capital, which in turn leads to an appreciation in its currency value. Conversely, there’s likely to be further downside pressure on the GBP as investors weigh the negative economic impact from the coronavirus.

Inflation. Countries with high inflation rates tend to have lower currency values. As the prices of goods and services increase at a faster rate relative to other countries, demand for the country’s exports falls, bringing about less demand for the country’s currency as well.

Political stability. Political shifts can trigger swift currency movements. The UK’s Brexit vote in 2016 is a classic example – the pound fell 20% before making a partial recovery. 

The mechanics of investing internationally

Syfe’s global portfolio holds USD-denominated Exchange Traded Funds (ETFs) and individual stocks. Investors have the option of funding their account in Hong Kong dollars or US dollars. For the latter, there is a minimum investment of USD $10,000 per transaction.

Many Hong Kongers prefer to use HKD to fund their accounts since they don’t hold US dollars. If you choose to do so, the first thing we do is convert your money into US dollars. Your portfolio assets are then purchased with the US dollars we’ve converted. 

When you wish to withdraw your funds, we receive US dollars when we help you sell your investments. We will then convert these US dollars back into HKD before depositing them into your bank account.

The same currency conversion process happens even if you were to purchase US ETFs and individual stocks through a broker. The difference is that Syfe bears the currency conversion fee as low as 0.002% to place trades from their HKD denominated accounts. Retail investors generally pay much more (between 0.5% to 0.7%) in currency conversion fees.

Currency movements and your portfolio 

When you view your Syfe portfolio, you’ll notice that your total profit or loss comprises two components:

Portfolio impact – the impact on your profit or loss based on your portfolio asset price changes.

Currency impact – the impact on your profit or loss based on changes in forex rates.

For the duration of your investment, your money is held in US dollars. The value of USD is pegged to HKD on a fixed range and this small fluctuation results in either positive or negative currency impact.

Simply put, if any overseas currency appreciates against HKD, i.e. HKD weakens, you make more money from your investment. For instance, in 2021, , the value of GBP rose against HKD by 0.45%.

In the above example, if you were to hold a GBP portfolio in 2021, you’ll receive more money because you get more HKD per GBP  based on the exchange rate. In this case, your currency impact will be +HKD$0.45 for every $100 HKD.

But if HKD appreciates against GBP i.e. GBP weakens, you’ll receive less money because your GBP will buy fewer Hong Kong dollars when you sell.

It still pays to invest globally

For investors with exposure to oversea assets, the weakening USD is likely to be seen as a bonus. If this trend continues, investors will likely enjoy a positive currency impact. This can provide pockets of opportunities for investors who have diversified their portfolios globally.

While currency fluctuations can affect your portfolio returns in the short term, in the long run, portfolio performance tends to outweigh currency impact. It still pays to ensure your portfolio is globally diversified when it comes to managing risk and seeking return.