Search for top-rated funds that invest in emerging market equities--as I did for a recent article--and you’ll find 24 fund share classes to choose from. This is a list of multiple share classes of just seven funds, offering investors a broad range of currency options.
It's always safer to invest in a fund with a base currency of your own domestic currency, unless you're deliberately making a bet on forex.
Take Skagen Kon-Tiki, for example. Norwegian fund provider Skagen is yet to be a household name among British investors, but it’s gathering more of a following in the UK and its Skagen Global fund manager was recently nominated for ‘Fund Manager of the Year: Global Equity’ by Morningstar’s pan-European analysts. The firm’s emerging market equity fund, Kon-Tiki, is available denominated in no fewer than seven different currencies: US dollar, sterling, euros, Swiss francs, and all the Scandinavian currencies.
Faced with such a range, which currency denomination should investors choose?
The risk of investing in emerging markets via a currency other than your domestic currency is two-fold, explains Morningstar OBSR fund analyst Oli Kettlewell. Let’s say you opt for a euro-denominated fund investing in emerging market equity. One risk is that non-sterling currencies weaken against sterling, which is particularly pertinent when you have different currencies for both the base currency of the fund and for the fund’s underlying securities. Another risk is the cost of the exchange rate transaction between translating euro returns into sterling. A potential double whammy of foreign exchange pain.
Add to this that there could be tax implications depending on your individual situation, and it’s easy to see why so many investors find multiple-currency conversions a headache.
“There’s a lot going on when you buy a fund that’s not denominated in your domestic currency,” says Kettlewell, adding that there a lot of moving parts. “Equity returns are volatile enough and if you throw a currency in the mix, it’s just one more thing to worry about,” says Kettlewell.
This is why some investors opt for the hedged share classes, whereby the fund manager employs a hedging strategy to minimise currency risk. (Though an interesting caveat is that currency hedging can actually increase the volatility of returns; for example, Japan equity funds hedged back to sterling have had a wider range of returns than unhedged investors so far this year. Hedged returns minimise currency risk, not return risk!)
The bottom line is that it’s “always safer to invest in a fund with a base currency of your own domestic currency,” says Kettlewell. So for us UK-based investors, that means ensuring you’re buying the GBP-denominated share class of your chosen fund.
Unless, of course, you really know what you’re doing when it comes to forex and, for example, you want to take a bet that emerging market currencies will appreciate against the euro, that the euro will appreciate against sterling, and that these events will converge in time for when you choose to sell your shares. If that’s the case, you’re a braver investor than I am.
