Currency risk: when the currency changes the result of an investment

Holding a share quoted in dollars while thinking in euros means being exposed to two factors at once: the share and the currency. The final result depends on both. This second factor, currency risk, often goes unnoticed because it is invisible in the share's price, and yet it can amplify or wipe out part of the performance. This article explains the mechanism with a worked example, the ways to protect against it and their limits.

The mechanism: two moves that combine

For an investor whose reference currency is the euro, the performance of a share quoted in another currency combines:

the change in the share's price in its original currency;
the change in the exchange rate between that currency and the euro.

Fictitious example. An investor buys a US share for $1,000 at a time when €1 is worth $1.10, that is about €909 invested. A year later, the share has risen 10% and is worth $1,100. But the dollar has weakened: €1 is now worth $1.20. The $1,100 is worth 1,100 ÷ 1.20 = about €917.

The gain in dollars is 10%, the gain in euros only about 0.8%. Conversely, if the dollar had strengthened (€1 = $1.00), the $1,100 would be worth €1,100, a gain of about 21% in euros. The currency worked in both directions.

Where does currency risk come from?

The quotation currency: any share quoted outside the euro area exposes you to a foreign currency.
ETFs and funds, even when quoted in euros, that hold securities in foreign currencies: the exposure exists, it is simply indirect.
The company's revenue: a European company that makes most of its sales in dollars is also sensitive to that currency, even if its share is quoted in euros.

Can you protect against currency risk?

There are products described as "currency-hedged", which largely neutralise the effect of the currency. A few points to keep in mind:

Hedging has a cost, which depends in particular on the interest-rate gap between currencies, and which reduces performance.
It also neutralises currency gains, not only losses.
It is never perfect.
Not hedging is a possible choice: the effect of the currency can vary widely from one period to another.

There is therefore no single answer: the question is whether you are aware of the exposure and whether it is proportionate to your horizon and risk tolerance.

Points of vigilance

Thinking in a single currency. Comparing the performance of a share in dollars with another in euros without converting gives a distorted picture.
Forgetting the indirect exposure of a world ETF or a multinational share.
Currency conversion fees: buying a share in another currency can involve conversion fees at the broker. See the impact of fees on performance.
Currency diversification is a dimension of a portfolio in its own right, like sectors or geographic zones: see how to diversify a stock portfolio.

Key takeaways

Performance in euros = performance of the share in its currency, combined with the change in the exchange rate.
Currency can amplify a gain, wipe it out or worsen a loss.
An ETF or a multinational company can expose you to currency without the quotation showing it.
Hedging reduces the effect of the currency but has a cost and also neutralises currency gains.

In Earnnest, amounts are shown in each security's currency; a total converted into euros states the rate and date used.

This article is for information and education only and does not constitute personalised investment advice. The figures in the examples are fictitious and illustrative. Past performance is not a reliable indicator of future performance.