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On Jan 15, the Swiss National Bank, to the surprise of most financial experts and individual investors alike, reversed the “cornerstone” of their monetary policy by de-linking the Swiss franc from the euro. The first couple of days brought dramatic market moves: After a spike of about 30% in the Swiss franc’s value versus the euro, the franc settled with a gain of about 20% against the euro and 18% against the dollar. And the Swiss Market Index (SMI) fell dramatically to 7900 from 9198; it would then have needed a 16% increase to regain the level it lost in the short period after the SNB announcement.
First, a bit of background: Expats often have different reference currencies for different reference currencies for different purposes. If, for example, they live in England and get paid in pounds sterling and plan to retire in the US, their reference currency for day-to-day expenses is sterling and for retirement it is US dollars. Expats also often carry a home currency bias with them. For individuals raised in the US, they often invest for retirement in dollars and in the early years overseas convert the costs of local expenses to dollars and find that they are comparing expenses to what they are used to back in the US. Most investors understand clearly that when they hold bonds or cash in a currency other than the currency they spend in, they are taking on additional risk of a change in the exchange rate. It is not uncommon for individuals to see cash held in another currency as “safe” because it is in cash; while, dramatic monetary-policy moves like the SNB’s are relatively rare, currency value appreciation or erosion can be significant over a few years time.
About the Swiss franc & expats: Individual investors with their reference currency in euros, Swiss francs, pounds sterling or other major currencies other than the US dollar, are often encouraged to invest in equities through stocks, index funds or managed funds that are denominated in their “home” currency. For example: many Swiss portfolios will have holdings in Nestle, Novartis and Roche. European portfolios will have companies like Unilever, Bayer and Total SA and British portfolios will hold companies like HSBC, BP and Vodafone. Similarly, this strategy is often used through country equity funds for broader diversification but the same principle. Professionals and individual investors alike reason that the portfolio will be better correlated (less risky) to their home currency and often times there is a strong familiarity with the companies as a big employer in their native country and a globally recognized brand.
As an individual investor whose future living expenses are likely to be in a currency other than US dollars, these allocations to stocks denominated in their home currency seem to make sense. The stock price is quoted in their home currency, the dividends are paid in their home currency and there is no exchange rate fee incurred if using their home currency to make the initial purchase.
But here’s the rub: Many large and small publicly traded companies alike, regardless of the location of their headquarters and stock listing(s), have a very strong correlation to the US dollar and to a lesser extent eros, sterling, etc. A closer look at the SMI movements last week show that the only component to hold its value was Swisscom; the Swiss telecommunications company with most of its revenue in Swiss francs. To truly understand your investment portfolio’s currency exposure as it relates to equity investments, you want to understand the cash flows, and revenue and expenses of the underlying companies.
Currency changes are only one risk that individual investors need to manage. If you are a long-term equity investor and your investment portfolio is meant to fund a retirement in a currency other than dollars, one of the best way to reduce risk is to have a higher allocation to cash, fixed income, real estate, and other investments that are truly and more highly correlated to your home currency, and a lower equity allocation than a US dollar-based investor may have. A well-diversified equity component makes sense in most investment portfolios but is more risky if your home currency is not dollars due to the high proportion of global business done in dollars relative to other currencies. For Swiss investors who have an over-allocation to Swiss equities, you have now seen clearly that the SMI, while quoted in Swiss francs, is a much more US dollar-correlated index. Lightening up on Nestle, Novartis, Roche and the financial sector may provide you better equity diversification (less risk) for the same expected return. Have this conversation with your advisor.
Some broad guidance: One goal of a successful investment portfolio for individual investors is to be prepared for a crisis before it arrives. Trying to react during an extreme-volatility event makes matters worse. The stock market plunge during the financial crises was only a problem if you sold at a big loss and did not buy back in before the markets recovered. The SNB action should encourage you to consider risks in your own portfolio. Countries, government entities and companies can all go bankrupt. Cash, bonds and stocks all have different risks. Derivatives ad other structured products carry risks that are more opaque. As an investment professional I don’t invest client money in anything that my average client cannot understand. The tried and tested ways of building a portfolio — diversification and having a long-term horizon — are critical. All investments have risks. Make sure you know what they are, and for the expat reader, currency moves can erode value quickly or slowly. If you hold cash in one currency that you know will soon spend in another currency, you are gambling with your cash. Make the exchange today to reduce your risk.
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