Why your portfolio needs currency diversification?

on May 7, 2012 in Currency, Home | 5,821 comments

Despite its status as the world’s reserve currency, it’s no secret the USD has been on a long steady decline. Given the state of the economy, the possible effects of financial stimulus, and the current state of interest rates, we believe the long-term trend is bearish. I would recommend you to diversify a portion of your USD denominated portfolio. The idea behind this strategy has to do with the fact that if you hold your investments assets in your local currency, then your portfolio will mirror the performance of the assets itself. Nevertheless, if assets suffer from a downturn, so will your portfolio’s value since no hedging investments were made. Alternatively, consider the impact of currency diversification if a portion of the portfolio had been invested in assets denominated in a foreign currency, say SEK for example. The success of this export-oriented Nordic nation is noteworthy and a strong commitment to sound public finances, including a robust fiscal policy framework, has been crucial for Sweden’s economic fortunes. In this case, the performance of the SEK and the underlying investments might have partially offset portfolio losses that were taken in your local currency.  Another approach to diversify a portfolio would be to allocate a part of the portfolio to a commodity currency. This will effectively hedge inflation risk to a certain degree, especially if the commodity currency is from an oil producing nation such as Canada or a gold and iron-ore exporter like Australia. Australia, Canada and even New Zealand’s dollars are all considered commodity currencies, and their economies have also been expanding healthily for some time now while the economies of the US, Japan and Europe remain rather sluggish. Investing in assets held in some of these currencies could also be beneficial to achieve a more diversified portfolio. You could also consider overweighting your portfolio in US large cap. Such position in a portfolio may help capture some of the domestic growth to come out of the globalization trend, without currency risk. How much of a portfolio should be allocated to currencies? It depends on the investor’s individual view on the USD. In the absence of a fundamental view, about 5% makes sense for a conservative investor looking for...