May 20, 2011
When you invest internationally, your overall return will rise or fall according to two factors: the foreign asset's market value in the local currency and that currency's exchange rate against the U.S. dollar. For a mutual fund that holds foreign assets, the portfolio manager may use several strategies to address the impact of currency fluctuations.
The value of the U.S. dollar fluctuates in relation to other currencies. Interest rate levels, supply and demand balances, and other economic—and political—factors affect the dollar's relative value. For U.S. investors holding assets overseas, currency fluctuations can influence returns in two ways: Weakness in the U.S. dollar compared with other currencies increases the dollar value of foreign assets, and strength in the dollar depresses the value of foreign assets.
Currency fluctuations increase or decrease the overall return of a security when it is sold and converted back into dollars. Suppose you buy a stock worth ¥100,000 when the U.S. dollar trades for ¥85—your purchase price would be $1,176.50. Now consider that the security's value remained steady at ¥100,000, but the dollar weakened to ¥80; in this case, your investment value would rise to $1,250. And if the dollar strengthened to ¥90, the stock would be worth $1,111.11. Changes in currency values also may affect the local price of a security. For example, if the dollar surges against the Chilean peso, U.S. consumers would pay less for Chilean exports, and demand for those products would likely rise. This, in turn, could increase revenues and profits for Chilean export companies and result in higher stock prices. The inverse is also true: A dollar weakened against Chile's currency could depress the stock price of a Chilean company that exports to the U.S.
If you purchase an international bond fund with underlying holdings in India and the U.S. dollar weakens against the Indian rupee, the dollar value of your fund's return will increase relative to its return in local currency. Conversely, if the dollar strengthens against the rupee, the dollar value of future interest and principal payments will decrease, pushing down the fund's return. The share price of an international bond fund may fluctuate more than the price of a U.S. bond fund due to its exposure to currency rates. But this is not a reason to avoid these investments. Many portfolio managers use selective hedging techniques in an effort to reduce currency risk. For example, if the manager expects a local currency to decline and the bond market in the country to improve, he or she might use a forward contract—an agreement to buy or sell an asset at a particular future time at a price set today—to hedge local currency exposure either back to the U.S. dollar or to a different currency.
Currency fluctuations may have less-dramatic effects on stocks than bonds because the fluctuations themselves may affect stock prices. For instance, an Indian company and its stock may benefit from a stronger dollar, which could spur exports to the U.S. The rise in the dollar has the potential to help offset the negative impact on the stock's value in U.S. dollars. On the other hand, if the dollar weakens against the rupee, some export-driven Indian companies, particularly those with a major presence in the U.S. market, might see their stock prices decline in local currency terms. Though investors could see the market value of their assets decline, they could reap gains when they convert the assets denominated in the now-stronger rupee back into the dollar. Again, the inverse also is true.
If you invest in mutual funds, you can benefit from experienced analysts and portfolio managers who monitor currency fluctuations in foreign stock and bond markets. You also can manage the effect currency changes have on your overall portfolio by diversifying among assets in a variety of countries and regions. Currencies move only in relation to one another, so holding investments in several markets can substantially reduce currency risk while helping you benefit from global investment opportunities.
The portfolio managers for T. Rowe Price's 20 international stock and bond funds examine currency risks and fluctuations when they make investment decisions. Each fund takes a slightly different approach, but in all cases, country and currency research specialists follow exchange rate movements within the context of each country's overall economic outlook. Investment teams continuously monitor factors such as capital flows, inflation forecasts, trade policies, real estate rates, and interest rate projections. They use this information to project how currency values are likely to change and how the changes may affect the value of local assets. However, currency evaluation is just one component a portfolio manager uses to determine the composition of a portfolio. Fundamental research about a company's prospects is a critical part of assembling a well-thought-out portfolio. Indeed, stock selection is the driving factor in managing currency exposure. To be sure, investment professionals examine currency issues when they invest in non-U.S. markets. But those issues are part of the broader tapestry of risk-aware decisions that T. Rowe Price makes on a regular basis.
Learn more about T. Rowe Price international mutual funds.
All funds are subject to market risk, including loss of principal. Funds that invest overseas are subject to additional risks, including currency risk, geographic risk, and, potentially, emerging markets risk.