Skip to main content

You are here

Blog Listing Page

Weakening Euro highlights currency risk

The recent decline of the euro relative to the US dollar has been widely broadcast, with the exchange rate reaching levels it hasn’t seen in nine years. Many investors are observing the impact of such a sharp currency devaluation on their international portfolios, serving as a reminder of the presence of currency risk in global investing.

Analysts point to growing concerns about the Eurozone’s economy as the primary reason behind the depreciating euro. Hopes for a Eurozone economic recovery abounded in 2013, and the euro appreciated against the dollar. But as 2014 unfolded and Eurozone economic data consistently disappointed, these hopes waned.  Meanwhile, the US economy continued to strengthen on a relative basis, further accelerating the euro’s slide.    

The impact of the tumbling euro on global portfolio returns sheds light on the presence of currency risk. Currency risk is defined as the potential risk of loss from fluctuating exchange rates when an investor holds foreign securities.  For U.S. investors, any potential gains or losses are realized when the proceeds from an investment are converted from the foreign currency into US dollars.

In volatile currency markets the impact of currency risk can be significant. As illustrated below, when FTSE All-World Index returns are measured in different currencies, the results vary considerably as currency returns fluctuate.

 FTSE All-World Index: Annual Performance Denominated in USD, GBP, JPY and EUR

 

 Source: FTSE as of December 31, 2014.  Past performance is no guarantee of future results.

Perhaps the best approach to interpreting this chart is to consider the perspective of each investor. As the euro’s dramatic slide began in 2014, the US investor holding a global portfolio was at a disadvantage, as foreign-denominated securities depreciated relative to the investor’s home currency, the US dollar. Conversely, the European investor whose portfolio included US dollar-denominated securities would have benefitted from the strength of the dollar. Reflecting this dynamic, the FTSE All-World Index in US dollars only returned 4.8%, relative to 19.3% when measured in euros. 

The reverse is true in a weakening US dollar environment. When the euro was appreciating relative to the US dollar in 2013, the European investor who chose to invest internationally was at a disadvantage.  For this time period the FTSE-All World Index returned 23.3% in US dollars, compared with 18.0% when measured in euros.

Such data fluctuations underscore the importance of understanding currency exposure and its potential impact on investment returns.  As the investing landscape has evolved to include markets around the globe, currency risk has become an increasingly important consideration.    

 

 

© 2015 London Stock Exchange Group companies.

London Stock Exchange Group companies includes FTSE International Limited (“FTSE”), Frank Russell Company (“Russell”), MTS Next Limited (“MTS”), and FTSE TMX Global Debt Capital Markets Inc (“FTSE TMX”). All rights reserved.

“FTSE®”, “Russell®”, “MTS®”, “FTSE TMX®” and “FTSE Russell” and other service marks and trademarks related to the FTSE or Russell indexes are trademarks of the London Stock Exchange Group companies and are used by FTSE, MTS, FTSE TMX and Russell under license.

All information is provided for information purposes only. Every effort is made to ensure that all information given in this publication is accurate, but no responsibility or liability can be accepted by the London Stock Exchange Group companies nor its licensors for any errors or for any loss from use of this publication.

Neither the London Stock Exchange Group companies nor any of their licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of the FTSE Russell Indexes or the fitness or suitability of the FTSE Russell Indexes for any particular purpose to which they might be put.

The London Stock Exchange Group companies do not provide investment advice and nothing in this communication should be taken as constituting financial or investment advice. The London Stock Exchange Group companies make no representation regarding the advisability of investing in any asset. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.

No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the London Stock Exchange Group companies. Distribution of the London Stock Exchange Group companies’ index values and the use of their indexes to create financial products require a license with FTSE, FTSE TMX, MTS and/or Russell and/or its licensors.

Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.

 

Blog Listing Page