Many years before I began trading in equities and funds, I was a currency trader. In fact, one of the main reasons that I stopped was because when I first started trading foreign exchange we had the French franc, the German Deutschemark and the Italian lira, amongst many other European currencies. After the euro came in, the entire currency market dropped on its head and thousands in the City, including me, left the industry.
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Luckily for me, back then I was still in my early training days at the Royal Bank of Scotland and so it was relatively straight-forward to realign my career path and move seamlessly into equities, which I did. Not so luckily for me, I worked directly under the watchful guise of Sir Fred Goodwin, aka Fred the Shred, the man who was later to become one of the most hated men in Britain after serial killer Fred West.
At the time that I worked for him (that’s Fred Goodwin, not Fred West) he was widely revered as a demi-God for his business and vision acumen. It was only many years later at the height of the financial crash in 2007 that the world came to realise that Fred’s vision wasn’t that great after all. In fact, for the most part, he showed himself to be more than just a little short-sighted and many would argue almost completely blind when he made that ill-fated decision to acquire ABN-AMRO, a decision which would later nearly bring the bank to ruin. Indeed, without the Government bail-out, that’s exactly what would have happened.
So, the currency market is an area that I know very well.
Currency markets are incredibly dangerous
And whilst I recognise that I’m not sharing with you anything that you don’t already know when I tell you that the currency market is incredibly dangerous, it may surprise you to know why I think it’s dangerous. It’s not dangerous because it’s volatile or that there are high risks involved, although both of those facts are absolutely true. No, it’s dangerous because most UK investors are exposed to currency risk and have no idea about it, and if you are anything like the average investor then that probably includes you.
Imagine the M40 motorway. It’s obviously dangerous if you try to walk across it with cars and trucks hurtling at you at 70 miles per hour, but it’s not so dangerous if you are sat at home watching the Sunday omnibus edition of EastEnders. And that’s the same with what is going on right now with 90% of investors. They have been poorly advised to buy into investments which leave them exposed to huge amounts of currency risk, and yet have no idea about it!
That’s because over the past ten years there has been a fundamental shift and growing trend towards building a ‘diversified’ portfolio. With an explosion of new overseas products, increased liquidity, lower international trading costs and much easier access to funds in previously hard-to-reach places, there has unsurprisingly been a boom in investors buying into global funds.
And by definition this also means that investors are exposing themselves not just to overseas companies but yes, you guessed it, overseas currencies.
The fog of war
Think about that for a second. Unless you are a professional investor with a specific knowledge of global equities and emerging markets then there is only one possible reason that you will want to invest in the US, South America, Japan, Australia, Europe or anywhere else outside of the UK – to reduce risk. That’s it.
I know this because I speak to investors who tell me this every single day of the week. And as confident as I am that night will follow day, I will tell you this. The reason that investors are making the cardinal mistake of investing in the currency market and getting away with it is because for the past 15 or maybe even 20 years, they have gotten away with it. And that is worrying.
It’s worrying because the British pound has steadily fallen against nearly all major currencies over the past two decades, which has meant that internationally based funds and equities have tricked investors by appearing to perform much better than they actually have.
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For example, did you know that over the last 15 years, sterling has fallen against the euro by 10%, the Japanese yen by 25%, and the US dollar by a whopping 30%?
This means that the investments that your financial advisor and fund manager have put together and recommended to you, haven’t actually performed nearly as well as you are being told. Moreover, if the purpose of your strategy was to reduce risk, then I hate to be the bearer of bad news, but I need to tell you that the entire premise of your strategy is not just flawed but has irretrievably broken down.
That’s because you are not investing just in equities at all. You are investing in a hybrid product of equity and currency which is a much riskier play. And if investors haven’t been advised of the risks that they are taking (which in 99% of cases, they haven’t) and investors haven’t been advised to hedge their currency risk through an option or futures contract (which in 99% of cases, they haven’t) then, yes, you guessed it, there’s a 99% chance that their portfolio is not suitable to their risk profile.
I’m not suggesting that any of this is your fault. To the contrary, I believe that it absolutely isn’t. It’s your financial advisor who should be telling you all of this and the fund manager making the risks clear. In other words, client suitability is the responsibility of the advisor to ensure the investments are right for you and it’s for the fund manager to disclose fully the risks of the fund. I’m not talking about a small footnote about how currency fluctuations can affect the value of the fund but a big red neon warning sign!
The little risk disclaimer that nobody pays attention to is nonsense. The truth is that the risk of the currency element of an international fund is at least as important if not more important as the equity element of the companies and as such the risks of both need to be made clear and understood.
Who’s been swimming naked?
There is a saying in the City which is that you only know who is swimming naked when the tide goes out. It’s something that I often think about – not the naked swimming bit, although I can see why that might grab some people’s attention. No, what I think about is how often I see the unassuming, retail investor who puts their trust into their advisor and ultimately pays the price for the ‘oversight’ of the so-called professionals.
And now with Brexit just around the corner and scare-mongering that the UK economy will capitulate (it won’t) and the pound will collapse (it won’t), more and more investors are throwing their money into global funds with no knowledge that it’s the equivalent of walking in front of oncoming traffic.
You should know that I am a proud contrarian and I pride myself on thinking differently. It has served me and my clients well over the years and so I shall leave you with this.
I think that you may well find that after an initial dip in the UK pound brought on by the hysterical media, that our currency actually recovers. And if that happens you better really watch out with those ‘safe’ overseas funds because you could lose heavily over the next few years if the pound recovers even some of the ground that it has lost to overseas currencies.
The irony is that there are tens of thousands of people across the UK right now who are being advised to restructure their equity portfolios out of the UK and into international funds to try to protect their investments from Brexit, whereas in actual fact what they are doing is perfectly positioning their portfolio right into the eye of the oncoming storm.
CEO of London Stone Securities