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Role Of Forex In Portfolio Management

Jul. 17, 2017 11:34 AM ETUDN
The Hermit Trader profile picture
The Hermit Trader


  • Investors often under-look the impact of Forex changes on their portfolio returns.
  • The USD has depreciated in value of late, and for overseas-based investors buying US equities, this would have hurt their overall returns when they convert back to their home currencies.
  • Investors can consider using currency hedges to mitigate the impact of Forex fluctuations on their portfolio returns.

The role and impact of Forex in a portfolio is often under-looked. Investors generally make Forex transactions in order to purchase assets such as equities and bonds. For example, if I were an investor hailing from Europe and I wanted to purchase US equities, I would sell my Euros to buy US Dollars, which will then enable me to buy Apple (AAPL) or Tesla (TSLA) stock.

However, investors may not consider how fluctuations in Forex may impact the overall returns on their portfolio. Appreciation in the investor's home currencies over that of the currencies his/her assets are denominated in will lead to reduced portfolio returns.

For example, using the same scenario as aforementioned, should the investor buy into US dollars from Euros to purchase Apple and Tesla stock, and should both Apple and Tesla stock rise by 20% each, his portfolio would technically enjoy a 20% increase in value. However, what if the investor had sold his Euros to buy US Dollars at 1.05, and the EURUSD exchange rate now stands at 1.15?

The investor would have lost about 8.5% from Forex fluctuations should he liquidate his portfolio and exchange his US Dollars back into Euros, his home currency. As such, the overall portfolio would only be up by 11.5%, or 20% minus 8.5%. This scenario is very real, as EURUSD had just recently moved from 1.05 to 1.15 levels within the past year.

On the flip-side of course, an investor's portfolio returns could also be boosted by favourable Forex movements. For example, a US-based investor might have invested 100% of his portfolio in European equities. Even if the equities have not generated any returns, the investor would have made 8.5% if he/she liquidated the portfolio and switched back into US Dollars from Euros.

Now, given the current market context, how is

This article was written by

The Hermit Trader profile picture
Using charts to trade the markets. Author of charting newsletter http://thehermittrader.substack.com

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