Your fund's currency exposure may not be what you think

(Oct 23): A client of mine was recently interested in a mutual fund that invests in Asian equities. It had a great investment track record and a solid manager; his main reservation was that it was denominated in British pounds (GBP). Given the continuing fallout from Brexit, he was afraid that GBP would depreciate in value against the Singapore dollar and therefore he could lose money in SGD terms even if the fund performed well. Is he right to be concerned?

The answer, which might be surprising to many, is that the fund has no GBP exposure even though it is denominated in GBP. Instead, its exposure would have been to the currencies of the underlying assets — that is, the Asian equities that the fund is buying.

This is an important concept to understand because currency exposure can make a big difference to investment returns. For example, let us say I had $1,000 invested in the UK stock market index ETF, denominated in GBP. During Brexit, GBP plunged in value from $2 to about $1.80 in less than a week. This would have resulted in a painful 10% loss for my position owing to currency depreciation (see Chart 1). In this case, I was exposed to GBP depreciating against the SGD, and was punished for it.

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