Author Topic: Currency risk/investing from a small currency - advice needed  (Read 966 times)

coconutindex

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Currency risk/investing from a small currency - advice needed
« on: August 01, 2017, 01:48:28 PM »
Hi all!

Thanks in advance to anyone willing to read this longish piece of prose.

I converted to mustachianism a few years ago and since then have been aggressively saving, appr. 50% savings rate. FIRE, if it happens, is at least a decade into the future, so everything I save goes into stocks/index funds. As I have only basic financial knowledge and want to keep things simple, I've decided on a portfolio of 10% domestic (Norwegian) stocks and 90% global stocks. For the latter I use a single fund which is low cost (0,30%, lowest you'll get here) and which incorporates both the developed and the developing world (MSCI Total World Index I believe is the reference they use).

As all my income is in our local currency - Norwegian kroner (NOK) - currency risk becomes hugely significant compared to people investing from a major currency such as USD. And most of the stuff you read online is based on the assumption that you're investing from USD or possibly euros. If the index rises by 10%, and NOK also increases in value by the same percentage - all my earnings will be gone. The textbook says that over time fluctuations in currency will tend to even out. But again, that surely must be in terms of the huge currencies who are tied to large economies. A small economy such as the Norwegian one - which is heavily tied to oil - is more unpredictable. So if I do FIRE, and end up having to sell funds at time our currency is strong, that will eat away at my earnings. Naturally the reverse could be true and I could benefit from a weak currency when I sell, but hey, I'm a pessimist.

Still- I am of course willing to accept the risk of international investing, but I am wondering if I should place some of my money in a fund which incorporates currency insurance. This is some sort of financial instrument that I never will understand in a million years, but the result is that fluctuations in currency value is evened out. The downside is that the insurance comes at a cost which is deducted from the value of the fund, so lower earnings. (Difficult to quantify how much). One relevant fund is available to me. It is total world minus developing countries, fee is 0,30%.

So, should I:
keep investing 10% domestic and 90% global without currency insurance, or should I allocate maybe 10-20-30% into a global fund that does have currency insurance (at the cost of lower earnings)? If I do the latter I would have a choice between two funds when I do need to start selling, so I could sell the insured fund if currency is high or the other one if currency is low. 

Any thoughts on this is greatly appreciated.

FI40

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Re: Currency risk/investing from a small currency - advice needed
« Reply #1 on: August 01, 2017, 02:00:05 PM »
USDNOK has been in the range of about 5 to 9 since 1971 (I just checked Bloomberg). It's a smaller currency yes but it's a developed country with a stable government and I don't think you should be so worried about crazy fluctuations messing with your investing. Some points to consider:

- you are effectively dollar cost averaging throughout your investing time horizon, you aren't doing a lump sum, closing your eyes and then checking it in a decade
- as time goes on I assume you'll add domestic bonds to your allocation. When you near retirement, the time you are worried about, you'll have a lot more bonds than you do now, so your currency exposure won't be so bad in the final couple years of accumulation.

I think what you are doing is fine, just have a plan to add domestic bonds as your net worth reaches certain milestones and that should cover you.

coconutindex

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Re: Currency risk/investing from a small currency - advice needed
« Reply #2 on: August 03, 2017, 11:08:24 PM »
Thanks for the reply! Hadn't thought to check the historical data.. I'll print it and re-read it whenever I freakout. Yes, I do plan to start buying bonds when endgame is approaching, whenever that will be.

Radagast

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Re: Currency risk/investing from a small currency - advice needed
« Reply #3 on: August 04, 2017, 12:03:22 AM »
Here is an analysis that includes Norway. https://finpage.blog/2017/03/25/investing-in-the-world-part-3/

From this post, I think a good starting point for most investors in the developed world (outside the US and probably Eurozone) is 25% your country's stock, 25% hedged US stock, 25% unhedged ex-your country ex-US stock, 25% your country's bonds. To the extent those are available.

coconutindex

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Re: Currency risk/investing from a small currency - advice needed
« Reply #4 on: August 04, 2017, 12:36:27 PM »
Very interesting article, thanks for the link! By hedged US, do you mean currency insurance, or something else? Why hedge the US and not the rest?

Panly

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Re: Currency risk/investing from a small currency - advice needed
« Reply #5 on: August 04, 2017, 01:05:30 PM »
First:  Don't you get a separate income stream in NOK when retired?  Doesn't the norwegian government provide unemployment money, a pension, etc?

That money should certainly keep flowing, also when the NOKUSD rate goes ballistic, right?

second:  If you're so afraid that Norway becomes super rich relative to the rest of the world (that's in fact your worry, nothing else) and you intend to retire there,  why don't you invest in your accommodation (for yourself, plus rentals maybe) ?
That reduces the need for fresh NOK's to pay rent.



third:  if the NOK rate is your worry in the future, why do you keep a rigid 90/10 investment now, while you are building up? 
Wouldn't it be smart to load up on non-NOK investments when the NOK is relatively strong,   and buy the NOK market when the NOK price went down the toilet? 

That way you maximise the purchasing power of your current income.


fourth: the distinction you make between "big" currencies and "small" is unimportant.  What is important is that you can pay your bills wherever you may be.

fifth:  if the NOK goes ballistic, you can always spend your winters in Thailand, living on your NOK dividends.










« Last Edit: August 04, 2017, 01:08:46 PM by Panly »

coconutindex

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Re: Currency risk/investing from a small currency - advice needed
« Reply #6 on: August 04, 2017, 01:25:39 PM »
Thanks for your thoughts, Panly.

1. If I do FIRE, I will have to make do on my own income till the age of appr 62 (if there are no changes). After that there will be a government pension. So that will help.

2. Investing in accomodation is definitely in the foreseeable future. Various tax incentives here make it wise to own real estate.

3. The reason for my fixed ratio is just to simplify things (i.e. laziness)  and also to avoid timing the currency market. What's considered a strong exchange rate for NOK now could change in the future. Feels logical to "NOK cost average."

4 is a valid point, and the Thailand option sounds like a good idea whatever the exchange rates!

Retire-Canada

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Re: Currency risk/investing from a small currency - advice needed
« Reply #7 on: August 05, 2017, 10:28:49 AM »
I'm in Canada and most of my investments are in USD and other currencies. I think currency risk is overblown despite the fact at the moment my investments are going nowhere for that very reason. It appears like a problem, but I don't think it actually is.

1. When CDN$ goes up my investment account value goes down on paper in CDN$, but we import so much in Canada this also means my buying power is higher in many cases. It definitely means I get more value per $ when I travel and I plan to travel half the year during FIRE at least until I get too old.

2. When the CDN$ goes down my investment account value goes up, which looks good on paper and does help when buying domestic goods/services, but it's not much help for travelling and foreign products.

Ultimately I think it will be a wash. It will help sometimes and it will hurt sometimes, but I can take action to mitigate any pain. If the CDN$ is low I can travel within Canada and put off expenses for non-essential foreign goods. When the CDN$ is high I can travel more and buy those nice to have items I have been thinking about.

Another way to think about currency is the value in your investment account in local currency is like the number of shares of a stock. What that number of shares will actually buy is what really matters. In the OP's example if the local currency goes up in value 10% and his foreign investments go up by 10% it looks like there was no return for that period, but in fact he has 10% more value in that account. It's just not obvious until you examine the buying power or relative value of the local currency.
« Last Edit: August 06, 2017, 03:16:19 PM by Retire-Canada »

neonlight

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Re: Currency risk/investing from a small currency - advice needed
« Reply #8 on: August 06, 2017, 10:56:23 AM »
Semi-related.

I have some NOK savings in Nordea. It's not a whole lot and even though it's fetching some small interest in my savings account I'd like to know if I can just roll it annually at, say, 3%?

Le Barbu

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Re: Currency risk/investing from a small currency - advice needed
« Reply #9 on: August 06, 2017, 03:00:19 PM »
As a Canadian, I hold 30% stocks in my own country. It's a lot more than Canada's market capitalisation +/-4% but I would not shoot for anything <20% for the reasons above.

The rest is splitted evenly between US and Ex-US stock markets via Vanguard VTI and VXUS. Are you sure you cannot buy these at NYSE? Low fees, broad indexes, perfect for mustachians!

Edging does not help neither your insurance. Currency fluctuations increase volatility but rebalancing your portfolio can offset this and increase returns. I do not edge anything!

If you are worry about currency and stock market fluctuations, a safe bet would be 25% home country bonds, 25% home country stocks, 25% US stocks (unedged) and 25% Ex-US stocks (unedged).
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neonlight

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Re: Currency risk/investing from a small currency - advice needed
« Reply #10 on: August 06, 2017, 08:00:05 PM »
As a Canadian, I hold 30% stocks in my own country. It's a lot more than Canada's market capitalisation +/-4% but I would not shoot for anything <20% for the reasons above.

The rest is splitted evenly between US and Ex-US stock markets via Vanguard VTI and VXUS. Are you sure you cannot buy these at NYSE? Low fees, broad indexes, perfect for mustachians!

Edging does not help neither your insurance. Currency fluctuations increase volatility but rebalancing your portfolio can offset this and increase returns. I do not edge anything!

If you are worry about currency and stock market fluctuations, a safe bet would be 25% home country bonds, 25% home country stocks, 25% US stocks (unedged) and 25% Ex-US stocks (unedged).

I am no expert but wouldn't doing that still keep you vulnerable by 75% to USD. Granted USD is different from other currencies.

banksie_82

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Re: Currency risk/investing from a small currency - advice needed
« Reply #11 on: August 06, 2017, 09:00:01 PM »
I also come from a ‘small currency’ highly developed western country – Australia. The difference is, the AU$ is one of the most heavily traded currencies in the world, due to it being a proxy for minerals and the Chinese economy. It’s not unusual for movements of 10% within the space of a couple of months. It appreciated 75% against US$ between ’09 and ’11 and dropped 35% between ’13 and ‘15.

While all three countries being talked about (AUS, CDN, NOK) have a fairly similar economy (highly dependent on minerals and resources), Norway has a massive sovereign wealth fund to help your economy ride the ups and downs. I don’t know the ins-and-outs of this, but does it provide some security to the average citizen in the street on a day to day basis?

What Australia doesn’t have, compared to Canada/Norway, is a huge single currency market on our doorstep, who is far and away our main trading partner. I’ve never really considered it, because it doesn’t apply to me, but can this act, in part, as a defacto domestic market when considering asset allocation? Surely many of your domestic companies would derive most of their earnings in the neighbouring market anyway.

Either way, I treat currency fluctuations as something that will come out in the wash in the long term. Obviously this only applies to developed, stable, western(?) currencies where the value tends to fluctuate around a mean. In the short term, it provides a useful, somewhat uncorrelated to other fundamentals, volatility that makes rebalancing more important and more beneficial to long term performance.

As to living off foreign currency investments in FIRE, I think of it as a hedge in itself. When local currency is high, foreign investments go down, but so does the cost of imports and international travel. In small economies, imports make up a large portion of what we consume. It would be impossible to get it exactly right and make currency movements a zero sum game, with respect to personal budgets, but there is that dampening effect there. Of course this isn’t the only reason for investing internationally and so other considerations need to be taken into account, but it’s a nice side effect.

neonlight

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Re: Currency risk/investing from a small currency - advice needed
« Reply #12 on: August 06, 2017, 09:08:23 PM »
I also come from a ‘small currency’ highly developed western country – Australia. The difference is, the AU$ is one of the most heavily traded currencies in the world, due to it being a proxy for minerals and the Chinese economy. It’s not unusual for movements of 10% within the space of a couple of months. It appreciated 75% against US$ between ’09 and ’11 and dropped 35% between ’13 and ‘15.

While all three countries being talked about (AUS, CDN, NOK) have a fairly similar economy (highly dependent on minerals and resources), Norway has a massive sovereign wealth fund to help your economy ride the ups and downs. I don’t know the ins-and-outs of this, but does it provide some security to the average citizen in the street on a day to day basis?

What Australia doesn’t have, compared to Canada/Norway, is a huge single currency market on our doorstep, who is far and away our main trading partner. I’ve never really considered it, because it doesn’t apply to me, but can this act, in part, as a defacto domestic market when considering asset allocation? Surely many of your domestic companies would derive most of their earnings in the neighbouring market anyway.

Either way, I treat currency fluctuations as something that will come out in the wash in the long term. Obviously this only applies to developed, stable, western(?) currencies where the value tends to fluctuate around a mean. In the short term, it provides a useful, somewhat uncorrelated to other fundamentals, volatility that makes rebalancing more important and more beneficial to long term performance.

As to living off foreign currency investments in FIRE, I think of it as a hedge in itself. When local currency is high, foreign investments go down, but so does the cost of imports and international travel. In small economies, imports make up a large portion of what we consume. It would be impossible to get it exactly right and make currency movements a zero sum game, with respect to personal budgets, but there is that dampening effect there. Of course this isn’t the only reason for investing internationally and so other considerations need to be taken into account, but it’s a nice side effect.

A not totally related question.

What is causing the AUD interest rates rise recently? There are several banks in APAC that is offering special rates ~2% for AUD lately.

Le Barbu

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Re: Currency risk/investing from a small currency - advice needed
« Reply #13 on: August 06, 2017, 09:25:41 PM »
As a Canadian, I hold 30% stocks in my own country. It's a lot more than Canada's market capitalisation +/-4% but I would not shoot for anything <20% for the reasons above.

The rest is splitted evenly between US and Ex-US stock markets via Vanguard VTI and VXUS. Are you sure you cannot buy these at NYSE? Low fees, broad indexes, perfect for mustachians!

Edging does not help neither your insurance. Currency fluctuations increase volatility but rebalancing your portfolio can offset this and increase returns. I do not edge anything!

If you are worry about currency and stock market fluctuations, a safe bet would be 25% home country bonds, 25% home country stocks, 25% US stocks (unedged) and 25% Ex-US stocks (unedged).

I am no expert but wouldn't doing that still keep you vulnerable by 75% to USD. Granted USD is different from other currencies.

No, only US stocks index expose me to US currency. Ex-US index VXUS.NYSE is traded in US dollars but expose me to every currencies arround the world.
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banksie_82

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Re: Currency risk/investing from a small currency - advice needed
« Reply #14 on: August 06, 2017, 09:37:26 PM »

A not totally related question.

What is causing the AUD interest rates rise recently? There are several banks in APAC that is offering special rates ~2% for AUD lately.

I don’t think that’s a recent thing. Our official interest rates are the lowest they have ever been, while at the same time being one of the highest in the developed world. The difference between what the official rate is, and the one offered by retail banks (for both borrowings and savings) has been creeping up lately. This is because:

1.   Our banks get a large portion of their funding internationally, and international rates are moving up
2.   Macro-economic controls by the regulator trying to slow down an insane housing market.

In Australia, high interest online savings accounts are offering close to 3% and have been for a while, although these are probably introductory rates for limited terms.

Radagast

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Re: Currency risk/investing from a small currency - advice needed
« Reply #15 on: August 06, 2017, 11:29:38 PM »
Very interesting article, thanks for the link! By hedged US, do you mean currency insurance, or something else? Why hedge the US and not the rest?
Some exposure to currency risk is beneficial. The US is a single country which has its own currency risk, compared to a large basket of currencies. It might also be cheaper and easier to hedge the dollar compared to a basket of currencies. That is something of a guess and you'll have to look into it for yourself, hedging the US may not be beneficial, or maybe you can't access that kind of fund or not for the right price.