Foreign Currency Risk – How Do You Minimize the Threat and Strengthen Your Portfolio?
The fast-growing foreign countries often lure most of the investors. However, the unforeseen risk of spoiling your returns looms at all times. American investors are often unaware of the risk from the foreign currency.
Identifying the risk from fluctuating currency is crucial to reducing the threat due to the forex market. This article highlights the ways foreign currencies can hit your portfolio and how to minimize the threats.
How Does Risk Work for Foreign Currency?
Broadly, when an investment or company relies on foreign currency, risk occurs as it must convert into a domestic currency. The foreign exchange rates can alter due to the fluctuations in the currency leading to a lower return on sales from the foreign country.
Investment in the foreign exchange market can help you to mitigate this risk. You can play this tactfully by choosing the specific currency of the target country with which you have a higher trade. However, it is advisable to trade cautiously, as there is an inherent risk of fraud in the foreign exchange market.
The availability of a higher trade margin with a small investment often leads to many people getting wiped off their crucial investments. Scammers use various ways to con the investors and seek unnecessary gains from it. However, you can rest assured that there are companies that help in forex scam recovery.
They help to accumulate data regarding the scam and fight the legal battle for the victim. The ancillary services support the victim during the recovery process, and their abundant experience is an added advantage.
The companies that have a significant amount of risk due to foreign currency fluctuations or for hedging as a tool to mitigate risk. They use several ways to shift the burden of risk and increase their return from foreign country sales.
The most prevalent way of hedging is to directly work with currency hedges such as future and options. At times, they also set up a production facility in the local country to reduce the currency risk significantly if the market looks promising.
Therefore when you invest in a foreign asset such as a bond or stock, you opt for two bets. One on the currency itself and the other on the success of the individual bond or stock.
It is worth mentioning that investing in US assets only can also pose a significant amount of currency risk. However, it can be significantly less when your company operations are taking place in a foreign land.
Ways to Curb Exposure
Trade Foreign Bond With Caution
Many investors often seek investment opportunities from foreign markets as the interest rates are low in developed markets. This approach can be dangerous at times with bonds.
Bonds typically give a lesser yield, and a fixed payout means that the currency fluctuations will not be able to wipe out your gains. The bond’s price and its future interest payment take a hit when the dollar strengthens relative to the foreign bonds currency.
Investors should steer clear of the foreign bond to reduce the impact of such significant risks. However, investors can gain from the foreign stocks as they appreciate rapidly and offer more headroom.
It makes sense to have a global diversification with the index funds that have a higher exposure to large currency areas. It can be the Euro area, the US, or Asia-Pacific.
Such diversification gives your portfolio a natural hedge. The non-dollar investment will have a tail end when the dollar becomes strong and vice versa. In case there are weak non-dollar assets, the dollar investments will have the extra tailwind.
Currency Hedged Funds
You can choose to have currency-hedged funds in your folio. It helps add the prospect of hedging to your fund holdings. It can be one of the easiest ways for neutralizing the currency risk by investing in a particular region or country’s stock.
This aspect allows you to invest in a fund that invests exclusively in the stocks of a particular area. For example, it can be a stock of the Euro area or Japan and help you hedge the exposure on your behalf.
To summarise, investors should not target a higher involvement of their portfolios in currency hedging. It is especially true in the event of investors having a diversified stock portfolio. Such a portfolio will help naturally provide the option to take cognizance of currency fluctuations.
For those who have heavy exposure to a particular currency, it makes sense to employ additional hedging techniques.