Gearing Liquidity and Risk · Investment Trusts
A sterling quote does not make an international portfolio a sterling investment in economic terms. Currency affects asset translation, company earnings and borrowing in different ways.
Trace the underlying currencies
Identify where assets are valued, where businesses earn revenue and where liabilities must be paid. These can differ from the currency used to publish NAV or trade shares. Company operations can also offset or amplify direct translation effects.
For a simple unhedged foreign holding, domestic currency return equals one plus the local asset return, multiplied by one plus the currency translation return, minus one. The multiplication matters because the effects compound.
Work through a translation example
A foreign asset gains 8% in its local currency, while that currency loses 6% against the investor’s measurement currency. Multiplying 1.08 by 0.94 gives 1.0152, a gain of 1.52% before costs. Subtracting six from eight would only approximate the answer.
The example isolates translation. It does not include changes in business earnings caused by exchange rates, hedging or debt. A real portfolio needs more detail than one currency conversion.
Read hedges as specific contracts
A hedge may cover some currencies, some assets and a particular horizon. Costs, collateral needs and imperfect matching can remain. A manager may also choose not to hedge. Do not infer the policy from a currency symbol on a trading screen.
Compare performance in a consistent currency and record the hedge policy. For portfolio construction, distinguish the company’s reporting currency from the currency in which you expect to spend or meet liabilities.
Try it yourself
A foreign asset falls 5% locally while its currency rises 4% against your measurement currency. What is the translated return?
Show the worked answer
Multiplying 0.95 by 1.04 gives 0.988, a loss of 1.2% before costs and other effects.
Further reading
Educational material, not a recommendation to buy or sell a fund. Numerical examples are hypothetical. This guide focuses on listed investment companies commonly called investment trusts in the UK. Product terms, access and tax treatment vary by jurisdiction.
