Perhaps it’s the financial writer in me, but our long-awaited holiday to Japan was hastened by a currency that had moved heavily in our favour; the same may be the case for the US next year.
We decided to take in the sights of Tokyo, Kyoto, Nara and Osaka in May, to take advantage of a weak yen. The GBP/JPY exchange rate had climbed by c. 50% over the past five years, from c. 130 five years ago to c. 195.
Sterling has climbed against the US dollar, too. Perhaps that will be our next big trip.
The GBP/USD exchange rate has risen c. 30% in the past three years, from c. 1.05 to c. 1.37 at the time of writing. You’ll recall that during the Truss premiership there were fears the pound would hit parity with the dollar.
Sterling’s four-year high against the dollar may be good news for holidaymakers, but it’s not so good for those UK-based investors whose portfolio is heavily weighted to USA Inc.
During this period of dollar weakness (since 28 September 2022), the S&P 500 has generated a total return of c. 70%, yet UK (and other Europe-based) investors have not kept up with this. The iShares Core S&P 500 UCITS ETF, denominated in sterling, is up c. 33.6%, according to FE fundinfo.
Currency movements are notoriously difficult to predict, but it’s prudent to at least consider the risk that depreciation could drag on your returns when investing overseas. The S&P 500 has powered ahead since 2022, but sterling investors would have been better off putting their cash into the iShares Core FTSE 100 UCITS ETF, which has returned 37.8%.
This is a far cry from the post-financial crisis period when a strong dollar worked in our favour. Indeed, the iShares Core S&P 500 UCITS ETF returned c. 354% in the 10 years to 28 September 2022, versus a US dollar return of c. 196% from the S&P 500.
Now, a rethink of this dollar dependence seems sensible. Bear in mind that president Trump wants a weaker dollar so that the US becomes more competitive from an export perspective as well as to shrink its trade deficit.
So, what, if anything, should a non-US dollar denominated investor do if the greenback continues to slide?
Most obviously, all things being equal, domestically oriented investments become more attractive. Broadly, this is because you don’t have to take on any currency risk – and we’ve already shown that in sterling terms the FTSE 100 has outperformed the S&P 500 recently.
The nuance here is that only c. 30% of FTSE 100 companies’ revenues come from the UK, with a large portion of that being US dollar sales. So, perhaps a more interesting place to look would be the UK small- and mid-cap segment, where companies are more geared to the UK economy. FTSE 250 companies generate c. 45% of revenues domestically and that number will be lower for small-cap firms.
Take Rockwood Strategic, which invests at the very bottom of the small-cap segment, in micro-cap companies. Rockwood Strategic’s portfolio generates roughly half of its revenue from the UK, with the other half coming from the US as well as continental Europe, Asia and Africa.
From a mid-cap perspective, consider Schroder UK Mid Cap, which has been boosted by its domestic exposure, such as housebuilders and other companies down the housebuilding supply chain including brick makers.
Emerging market economies have tended to be negatively correlated with the US dollar in that when the dollar rises, emerging markets generally do badly. If this is the case, it’s fair to suggest that the reverse should hold true and that as the dollar continues to weaken, emerging markets will thrive.
That’s particularly true of the countries at the smaller end of the emerging complex, which tend to have more US dollar debt, suggesting that BlackRock Frontiers could benefit.
Fidelity Emerging Markets is an interesting option here, in that it is a differentiated option in the sector. Managers Nick Price and Chris Tennant are very valuation-focused, giving them the flexibility to stray from the benchmark, which leads them into small- and mid-caps, as well as having the ability to short companies with weak balance sheets.
A further asset class that has benefited from lower dependence on the US dollar as a source of funding is gold. Aside from it doing well in an uncertain geopolitical environment, central banks in countries with big US dollar revenues have been diversifying and reducing their exposure to the currency. To do this, they’ve been buying physical gold.
One beneficiary of this trend has been Golden Prospect Precious Metals, which continues to be a standout performer with a share price total return of c. 79% over the past year. High conviction exposure to smaller-cap miners, where the managers still see compelling valuations, has contributed to this and Golden Prospect Precious Metals still trades on a discount of c. 15%.
Of course, this is not all to say that wholesale portfolio changes are merited. The US market continues to chug along and it’s possible that the dollar could perk up at some point. However, most signs suggest that an ever-strengthening dollar will no longer provide a big boon to returns from your Stateside exposure. Diversification seems more important today than ever.
David Brenchley is an investment specialist at Kepler Partners. The views expressed above should not be taken as investment advice.