2012 currency impacts

Last week we discussed how owning international securities adds an extra layer of risk, due to currency exchange rates. This time we look at the actual year-to-date return of major indexes, both before and after currency conversions. The big currency fluctuations may not be where you would have expected.

Good year for equities

When you look at year-to-date equity returns around the world, it’s almost all good news.  Most stock exchanges are up this year, with the US leading the way. Only Germany and Hong Kong have done significantly better.  Spain, without surprise, is trailing the pack.

Year-to-date index returns, through 10-30-12. Source: Bloomberg.

As we discussed last week, investments in foreign stocks include two elements of risk and return – the inherit performance of the stock or index, and the effect of converting from and back to dollars when buying and selling. The chart above shows the year-to-date performance of several major indexes in local currencies, as well as the dollar return – the return that US investors would have experienced after the impact of exchange rates.

It depends where you invest

As you would expect, the currency impact depends on geography, but overall it has been fairly muted so far this year. Most notably and amazingly, after all the headlines about euro-collapse and dollar debasement, the currency effect has been close to nothing.  A US dollar-denominated investor in the DAX would have essentially the same 23 percent return as a German investor using euros. This is a rare case, not one we would expect to repeat in most years.

But not all currencies have tracked so closely with the dollar this year. Thanks to currency movements, US investors in the NIKKEI have earned less than yen-based investors, while a strengthening peso has provided US investors in the Mexican market a big boost in returns.

The currency impact in Brazil has been the most obvious. That country’s BOVESPA index has made a modest gain for Brazilian investors, but the weak real means that US investors have a loss of 7.83 percent this year. They own the same companies, but reap very different returns.

Foreign investments add valuable diversification to a portfolio, but we suggest discipline and caution when making allocations to international equities and fixed income. Excessive international holdings can result in a portfolio that is unduly driven by exchange rates. That’s why we always consider the portfolio picture, a revealing graphical representation of foreign exposure when building a new client portfolio.