Currency Risk In A Retirement Portfolio

A retirement portfolio holding international assets carries two moving parts: the value of the assets themselves and the value of the currencies they are priced in. The second is easy to overlook.

The exchange rate is a separate return

An overseas holding can rise in its home currency while falling in the investor's currency, or the reverse. The two effects combine into the return actually experienced.

This means the volatility of a foreign holding, measured from home, is generally higher than its volatility measured locally, because currency movement adds to it.

Over long periods the currency contribution to return tends to be small relative to the assets, but over any particular decade it can dominate.

Spending currency defines the exposure

Risk is only meaningful relative to what the money must buy. A retiree who spends entirely at home is exposed whenever assets are held elsewhere.

A retiree who spends part of the year abroad, or who owns property in another country, has liabilities in that currency and so is partly matched already.

Matching the currency of assets to the currency of future spending is the underlying principle, and it explains why the right answer differs by household.

Bonds and equities behave differently

For bonds, currency movement is frequently larger than the yield itself, which can overwhelm the stability that the bonds were held to provide.

Equities are more volatile to begin with, so the additional currency variation forms a smaller proportion of the total, and its diversifying effect can offset part of it.

This asymmetry is why hedging conventions often differ between the two asset classes within the same portfolio.

Hedging removes the exposure at a cost

Currency hedging uses contracts that offset the exchange rate movement, leaving the local asset return. It does not remove market risk, only the currency layer.

The cost depends on the interest rate difference between the two currencies, so it is not fixed and can change substantially as monetary conditions shift.

Hedged and unhedged versions of the same fund can therefore diverge considerably over time, even though they hold identical underlying assets.

Domestic concentration is the other risk

Avoiding currency exposure entirely means holding only domestic assets, which concentrates the portfolio in one economy, one set of industries and one policy environment.

For investors in smaller markets this concentration can be severe, since the domestic market may be dominated by a handful of sectors.

The decision is therefore a trade between two exposures rather than a choice between risk and safety, and the tax treatment of each route varies by jurisdiction and over time.