Exchange rate movements may hit fund profits

Dollar sign

Investors with funds invested in dollar-based assets could see themselves lose out because of the pound’s strong showing against the dollar – meaning their funds will be worth less when they are converted back into sterling.

Sterling has bounced back against the US dollar, hitting a two-week high early on Tuesday 8 September. Sterling gained over 1% to hit $1.6523, as the rising equity and commodities market bolstered risk sentiment, and by better-than-forecast monthly manufacturing production figures.

Duncan Higgins, senior analyst at Caxton FX, predicts the pound will continue to regain some value against the dollar in the lead up to Christmas.

But this rally is bad news for investors in dollar-based assets. For example, money in a North American fund tracking the S&P 500 index has risen about 50% since early March. But the real returns for UK investors could be more like 28%, because the pound has strengthened against the dollar since then.

Research from Interactive Investor shows that over the year to 7 September, investors in US funds may actually have lost money. Although the S&P is up by 12.5% in 2009, the pound’s strong showing against the dollar – up 14% since the start of the year – means they could be down over 1% in currency-adjusted terms.

“Sterling has benefited from more positive market sentiment and a return of risk-taking,” says Interactive Investor’s head of investment products, Rebecca O’Keeffe.

It’s not just funds invested in US dollars that are likely to be affected. Sterling investors in Japanese funds, for example, could have lost out this year, because even though the Nikkei index has grown by 17%, the strength of the pound - up 16% against the yen - has offset the equity return.

"Sterling has risen aggressively against major currencies in 2009, so in many cases, investors may find they have missed out on significant equity market returns and in some cases actually lost money," adds O'Keeffe.

However, Martin Bamford, managing director of IFA Informed Choice, points out that investors should not be too concerned. Movements tend to even out over the long term, so they will benefit when sterling weakens against other currencies.

“Some international funds are allowed to protect their returns against exchange rate fluctuations by hedging – but that costs money, so managers have to weigh up whether it’s worthwhile for short-term currency movements, as it could reduce long-term returns,” he explains.

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