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 Singapore’s borders has its advantages, fluctuations in exchange rates can affect your portfolio – especially in the short term.
Why exchange rates fluctuate
Currencies are always fluctuating in price against one another as they are traded on the foreign exchange (forex) market. 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.
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.
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.
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 US-denominated Exchange Traded Funds (ETFs). Investors have the option of funding their account in Singapore dollars or US dollars. For the latter, there is a minimum investment of USD $10,000 per transaction.
Many Singaporeans prefer to use Singapore dollars 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 SGD before depositing them into your bank account.
The same currency conversion process happens even if you were to purchase US ETFs through a broker. The difference is that Syfe customers pay a very low currency conversion fee of 0.1% to place trades from their SGD denominated accounts. Retail investors generally pay much more (between 0.5% to 0.7%) in currency conversion fees.
Currency movements and your portfolio
Sometimes, currency movements work for you and other times, they work against you. 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 relative to SGD is constantly changing, and this fluctuation results in either positive or negative currency impact.
Simply put, if USD (or any overseas currency for the matter) appreciates against SGD, you make more money from your investment. For instance, between 22 August and 3 September 2019, the value of USD rose against SGD by 0.57% to reach a high of 1.3915.
In the above example, if you were to sell on 3 September, you’ll receive more money because you get more Singapore dollars per US dollar based on the exchange rate. In this case, your currency impact will be +S$5.71.
But if SGD appreciates against USD i.e. USD weakens, you’ll receive less money because your US dollars will buy fewer Singapore dollars when you sell. In the example below, your currency impact will be -S$12.72.
It still pays to invest globally
Day to day, currency changes can be volatile. But is this cause for investors to avoid diversifying their portfolio globally?
Over the past year, SGD appreciated very modestly against USD, strengthening from about 1.36 per US dollar on 1 January 2019 to about 1.35 per US dollar on 31 December 2019. During the period, the S&P 500 was up 28.9% for 2019, its biggest one-year gain since 2013. An investor who avoided the US market because of the numerous currency swings that happened in 2019 would also have missed out on the portfolio gains from the US stocks rally.
Seen over long periods of time, the effect of currency impact on overall portfolio performance tends to be small. For example, the 10-year return for Syfe’s 15% Downside Risk portfolio is 10.17% (in USD terms), while SGD has gradually strengthened against USD by about 0.35% per year on average over the last 10 years. This is consistent with the Monetary Authority of Singapore’s (MAS) policy of allowing the Singapore dollar to appreciate on a “modest and gradual” path.
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.