If you're an expat, investing for retirement has an added layer of complexity, because in addition to the ups and downs of the stock markets, you also have to cope with currency swings.
Currencies move against each other all the time and sometimes the swings can be dramatic. For example, the pound has now fallen by more than a quarter against the US dollar since the financial crisis, while the South African rand has been declining for years.
Foreign exchange shifts can be a major threat to internationally-mobile expats earning dollar-linked dirhams in the UAE, while ultimately planning to retire in a country with a different currency altogether.
That is less of a worry for those who plan to return to the US, because the dirham is pegged to the dollar and rises and falls in lockstep. However, it is a different matter if you are aiming for the UK, France, Spain, Australia, Canada, India and many other countries.
If you build your long-term wealth in one currency then suddenly need to convert it into another when you retire, you are storing up a huge amount of risk that could bite you later. You don't want to discover your hard-won retirement savings are worth a third less because of currency shifts, as that could cost you hundreds of thousands of dollars that you may struggle to recover.
Thankfully, there are two things you can do to protect yourself — one simple, the other a little more complicated.
The simple version works particularly well if you are in the early stages of building your retirement savings, and years away from deciding when and where you will retire.
Stephen Thomas, associate dean of MBA Programmes at Cass Business School in Dubai and London, says younger expats should consider splitting their portfolio evenly across the US dollar, sterling and euros, to give broad currency diversification.
"Foreign exchange swings are totally unpredictable. Nobody knows where they are going to move next, which is why it’s so important to spread your risk,” he says.
Saving in one currency is a gamble that can either work for you or against you. “If you have saved in dollars but are retiring in pounds, right now would be absolutely brilliant,” he says. “It wouldn't be so good if things were the other way around.”
Mr Thomas says you can still take advantage of favourable currency shifts along the way. “If I was 25 or 30, I would be loading up on sterling-denominated assets right now, like stocks and property. This is an extraordinary moment for the UK, but the pound will eventually bounce back.”
Vijay Valecha, chief investment officer at Century Financial in Dubai, says it is worth remembering that during a period of hyper-inflation Zimbabwe once printed a trillion dollar currency note to cope with the huge depreciation of its currency. “That’s an extreme case but highlights the risk of adverse currency movements and the damage they can do to your portfolio,” he says.
Diversification is a simple way to give yourself inbuilt safety. “There are no sure shots in life, so don’t put all your eggs in one basket,” Mr Valecha adds. “If your home currency depreciates massively at any point, that will erode the purchasing power of investment savings.”
Even if you are pretty sure which country you are going to retire in, wider exposure makes sense. British expats who kept all their retirement savings in sterling will have seen them drop sharply in international terms. “Inflation tends to rise when a currency depreciates, pushing up the cost of living, plus you may also struggle to afford even a good quality overseas vacation,” he says.
The simplest way to get broad-based stock market and currency exposure is to invest in a low-cost global exchange traded fund (ETF) such as Vanguard’s FTSE All-World ETF (VWRL), Mr Valecha says. “This holds a spread of global stocks with 50 per cent of assets in US dollars, which gives you broad currency diversification that largely reflects the global economy.”
Complicated: hedge currency risk
As you approach retirement, you may want to rebalance your portfolio and start building up direct exposure to your home currency, the one which you will eventually use for your retirement wealth.
This is where things get a bit more complicated, although not too complicated.
Chris Davies, chartered financial planner at financial advisers The Fry Group in Dubai, says it makes sense to narrow down your objectives and reduce currency exposure as your future starts to become clearer.
Most major ETFs and many mutual funds give investors the choice of several different currency share classes, most commonly dollars (USD), pounds (GBP) and euros (EUR), allowing you to check ongoing fund performance in the currency that suits you best.
However, Mr Davies says that all this does is display the fund’s value in your own currency, while it does nothing to eradicate risk. “If you buy, for example, an S&P500 ETF denominated in GBP, it simply quotes the fund’s value back to you in pounds. The actual return is still generated in the underlying currency, in this case US dollars, which still leaves you exposed to currency risk,” he says.
Vince Truong, a partner at Holborn Assets in Dubai, says your ultimate return will therefore depend both on how the US stock market performs, and how the pound performs against the dollar.
“So if the US stock market goes up but sterling also rises relative to the dollar, the increase in equity values will be muted by the strengthening pound," he explains. "If the US equity market goes up and the pound weakens, then you get both equity appreciation with currency appreciation on top, accelerating your returns.”
However, most investors will not want to play the market in this way, as currency swings are unpredictable and can make your portfolio highly volatile.
You can largely wipe out your exposure by investing in a currency-hedged ETF, which use forward exchange contracts to hedge against fluctuations, giving you the underlying return of the assets, but in your chosen currency. “So in this case you would get the actual return from the S&P500, but in GBP,” Mr Truong says.
The iShares S&P 500 GBP Hedged UCITS ETF (IGUS) and The Lyxor S&P 500 UCITS ETF- Daily Hedged to GBP (SP5G) are just two of many ETFs that offer this. WisdomTree Europe Hedged Equity Fund (HEDJ) gives exposure to Europe but reduces euro volatility relative to US dollar.
Hedging is particularly important if your home currency is highly volatile, but Mr Truong says it isn't always possible. “Most ETFs are only hedged to major currencies, so if you’re retiring in, say, a smaller country in Asia, you probably won’t be able to hedge for its currency.”
He suggests checking your portfolio’s exposure to different currencies. “For most expats, a diversified approach is best until you are close to retirement, when a greater portion of your portfolio should be hedged to that destination,” he says. “If holding ETFs, changes are simply a matter of making some trades, while keeping an eye open for transactional costs and potential tax implications.”
Stuart Ritchie, director of wealth advice at AES International, says an added complication is that many expats don’t know where they will retire until the last minute. “It might be back home to the UK, Australia or South Africa – or Canada, Spain or Costa Rica. On this basis, currency is less important than having a globally-diversified portfolio.”
Spreading risk in this way is more straightforward than hedging. “If your investment portfolio has been carefully constructed, you should be able to remain calm and disciplined despite downturns,” Mr Ritchie says. “Reacting to events can often damage returns.”
Mr Davies says planning for currency risk is complicated. "For most individuals, we believe it is important to hold a diversified portfolio and receive bespoke, qualified and regulated advice.”