Saltydog: keep watch for ruinous exchange rate movements

The Brexit outcome will have a big impact on the value of sterling versus the dollar, and substantial consequences for UK investors.

Since Christmas, the pound has strengthened against the dollar and other currencies. A pound was worth $1.27 in December, but it was worth $1.33 by the end of February – a rise of 4.5%.

Over the past 10 years, the pound has spent most of the time trading at between $1.45 and $1.60. It peaked in 2014 at just over $1.71, but by the time of the Brexit vote it was back down at $1.45. On the evening of the vote, it briefly went above $1.50, when it looked like the Remainers had a majority in the bag, but it soon dropped once the vote to leave the EU became apparent. At one stage, the pound fell to almost $1.20. It has not risen back above $1.45 since.

Saltydog Ocean Liner performance graph


Exchange rate risk

To a sterling investor holding some funds denominated in dollars, or with assets or earnings denominated in a foreign currency, the outcome of the Brexit process is hugely important. A hard Brexit is likely to cause sterling to fall in value and thereby increase the value of dollar-denominated investments. A soft Brexit would produce the opposite outcome. In the first scenario investors would enjoy a financial gain, and in the second they would suffer a loss.

Technology and pharmaceutical funds as well as funds based overseas will be affected by Brexit one way or another, and most investors will have such funds in their portfolios. As the moment of ‘Brexit truth’ approaches, we should all be positioning to protect our finances.

The funds in the Saltydog portfolios are valued in pounds, so they are heavily affected by the dollar-sterling exchange rate. To underline the point, consider the following scenario.

  • 100 US shares valued at $10 a unit have a total value of $1,000.
  • At an exchange rate of $1.20/£1, they are worth £833.33 to a UK investor.
  • If the value of the units increases by 10%, they then have a value of $1,100.
  • If during this same period sterling increases in value relative to the dollar by 10%, the exchange rate will move from $1.20/£1 to $1.32/£1.
  • Now your $1,100 is worth £833.33, and you are back where you started.

At Saltydog, we believe in being active in the selection of the sectors and funds we hold in our portfolios. So we moved strongly into cash during the last quarter of 2018, as many of the Investment Association sectors started to fail – this is clearly reflected in the Ocean Liner portfolio graph above, and in the pie chart. As a result, we managed to avoid most of the corrections in world stockmarkets.

Now we are starting to cautiously move back into the markets, as they are showing signs of recovering. UK sectors are of particular interest because they are undervalued as everyone waits for the Brexit negotiations to be completed.

A pie chart showing how Saltydog allocations have shifted towards risk reduction

This is the time of year when fund managers’ performance figures are published. Of particular interest are the figures for underperforming ‘dog funds’. These are funds that fail to keep up with the average performance in their sector. It astounds me that there are literally tens of billions of pounds sitting in such funds – entrusted by the public to financial managers for safekeeping.

These same managers decry those, like us at Saltydog, who suggest that people should actively manage their investments. They say we are misguided in trying to time the market and that their ‘buy-and-hold’ approach will eventually win out. The Financial Times recently published an article demonstrating that many own-brand funds run by Hargreaves Lansdown, a firm advocate of buy-and-hold and the largest fund platform in the country, feature among the dog funds, despite the firm having very high management charges.

It is a shame investors are unaware of this or don’t have the confidence to take control of their investments. After all, it is just a matter of experimenting using up-to-date fund performance numbers. It’s not rocket science; it just requires taking small steps while you learn. Meanwhile, we should be in no doubt about the source of the wealth that pays for fund managers’ salaries, bonuses and luxury motor cars – you.

Douglas Chadwick is a founder director of Saltydog Investor.

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