Market makers: The forex factor of investing - The Age
“But, if the Aussie dollar rises in value, then your return on your US$100 return will reduce as you convert your investment back to the local currency,” he adds.
One way investors can manage foreign exchange risks in their portfolio is by checking whether their investments have a built-in currency hedge. For instance, some investments are hedged, which means the assets’ returns or losses won’t be affected by currency movements. Other investments will be unhedged, which means their returns may be positively or negatively affected by currency movements.
Says Foley: “When a portfolio is hedged, the investment manager uses certain financial instruments to strip out the effect of currency movements on the primary investment assets. If your portfolio does have these features, the next step is to check how that’s done and the cost.”
Alternatively, you may choose to deliberately be exposed to currency risk, which is when the portfolio is unhedged. In the example above, if the value of the Aussie dollar is above the value of the US dollar, which is rare and unlikely to be sustained over the long-term, an investor may choose to allow their investments to be fully exposed to currency movements in the expectation a falling Aussie dollar increases returns from the US$100 investment.
Diversification is another way for investors to manage currency risks. Diversification in an investment portfolio involves investing across a number of different asset classes to minimise the risks of the highs and lows in the market.
“This could mean investing in shares, bonds, ETFs, real estate, cryptocurrency and even gold. Instead of rolling the dice on one type of asset and risking the loss of money due to a change in exchange rates, holding foreign investments can serve as protection in case the Australian economy crashes,” says Gerry Incollingo, managing director of financial advice firm LCI Partners.
Managing wealth and trading currencies requires good planning and strategy. So ensure you understand why you’re investing and make sure you always take a disciplined approach, taking into account variables such as currency movements over time.