FX exposure in an ISA wrap

the_learner

Hi, I was looking at some alternatives to gain some exposure to EUR and USD currencies with Fidelity.
Without adding any equity/bond risk to this activity, I have found few solutions with cash funds. Some Fidelity cash fund could be used to switch money from GBP to EUR or USD.

Anyway, they have an annual 0.4% fee so I was wondering if there is any cheaper alternative I could use.

Further, do you think this could be a good way to gain exposure to FX?
Any experience to share?

Thanks.

P.S. Sorry but I can't post links to the funds apparently.

IronWolf

It would probably be easier and cheaper to use spreadbetting. I have foreign holdings in my ISA which I hedge by spreadbets on currency futures.

bowlhead99

Same here.

Using up your precious ISA allowance to hold a foreign currency fund which has no expectation of generating substantial income or gain, doesn't make much sense to me. If you want exposure to an expected strengthening dollar or euro for the long term, invest into funds that hold companies or real estate with high USD or EUR assets and incomes. That way you will be generating income and growth whether or not your call on the currency movement is correct, and an FX gain is just the cherry on the top. It is strange to want currency risk but not be willing to take investment risk.

Sure, people do hold assets from time to time (such as gold) which are purely speculative and do not generate income or inherently 'grow', as part of their portfolio. But at least gold as a commodity has some inherent industrial usefulness and has acted as a hedge against inflation over the long long term. Cash does not; it always becomes less and less valuable over time.

So, if you buy a foreign currency money market fund you are dooming yourself to suffer inflation as well as fund manager fee as well as platform fee, on a speculative punt that the exchange rate will move the way you think it will. And if you think the currency markets will move the other way (GBP strengthen), how would you incorporate that in your strategy? Once you sell the USD fund down to zero, you can't keep selling it to bet on GBP strengthening.

The other aspect is whether the currency funds you are considering are even marked as 'ISA allowable' by your provider? They weren't in the old days (because cash had to be in a cash ISA and foreign currency wasn't allowed in a cash ISA) but perhaps NISAs since July have changed that. You could always consider investing in a fund that holds short-dated foreign currency bonds I suppose - probably making small losses on the fund value after fees but allowing a potential gain through currency. I still wouldn't recommend it though.

You could do this outside of an ISA without touching your ISA allowance by simply buying a large amount of foreign currency cash or travellers' cheques and putting them under your bed, to sell at a profit when the currency they are denominated in has hopefully strengthened. However with real hard currency, FX dealer's commission (spread) is always high so it's very inefficient. Slightly more sensible would be to open a foreign currency bank account where your funds are electronic and can be wired back and forth to currency brokers to do your exchanges. My Citibank account gives me USD and EURO and GBP all off one debit card.

But really, if you just want to make a relatively short term bet on the direction of currency rates, I would agree with Ironwolf that a spread bet is the best solution, and tax free. Of course, you would want to be careful about how much you can afford to bet and whether you want to use any guaranteed stop-losses. An advantage of using a spread bet is that you don't need to provide all the cash up front because the FX rate is never going to drop from 1.62 to 0.00 or increase to 999999. However, this does mean that your eventual loss could well exceed the small amount of cash you put in, if you don't set a stop position to close you out automatically at a certain rate.

the_learner

Hi IronWolf and thanks for the answer.

I am only allowed to use mutual-funds because of some restrictions applied to my job (I work as a consultant).
For this reason I am looking at solutions that can give me exposure to EUR (in particular, as I am from Eurozone).

The idea is: I live in UK and earn/spend in GBP terms but I still have a link to Eurozone so I would like to avoid my money to drop in EUR-terms (because of FX rate going up).

So I was thinking to hold the money in a EUR cash fund and keep the money protected in EUR-terms.

Still need to decide if it's better to keep it inside the ISA or outside. After all this money would be subject only to FX risk so probably better to keep it outside the ISA.

What do you think?

bowlhead99

If for regulatory reasons you aren't allowed to use a spreadbet provider to take out a bet on the direction of currency movement, you'll need to stick to funds or bank accounts. You may want to check that with the Compliance dept at the company where you're contracting - because depending on the nature of your client's business there may be other financial instruments you are allowed to use that they haven't thought to include on their standard policy document. For example a share in, or bet on, an individual company might be prohibited, but an ETF or spreadbet on a wide index of shares, or the exchange rate between two countries, may be OK - your activity is not going to be big enough to move the market, damage a client's interest, or be the result of inside information.

I would have thought that if you don't want to take investment risk with your spare money, and want it to be denominated in EUR, then the simplest solution is to put it into a EUR bank account, surely . With Eurozone interest rates where they are at the moment (base rate 0.050%) you are not going to earn any significant income off it so tax wouldn't be a problem. So you could use a bank account back home in the eurozone, or here in UK, or somewhere neutral like Gibraltar, Channel Islands or Isle of Man (http://international.lloydsbank.com/international-savings/)

If you don't mind a bit of investment risk, and some of this cash is not going to be needed for many years until you are back in the Eurozone, it would make sense to consider investment funds in your ISA that have a Euro focus on what they invest in. Of course, you may find that UK, US, Japan etc perform better than the Eurozone over the next decade and so it makes sense that any investment funds in your ISA are spread around geographically.

the_learner

bowlhead99 wrote: »

If for regulatory reasons you aren't allowed to use a spreadbet provider to take out a bet on the direction of currency movement, you'll need to stick to funds or bank accounts. You may want to check that with the Compliance dept at the company where you're contracting - because depending on the nature of your client's business there may be other financial instruments you are allowed to use that they haven't thought to include on their standard policy document. For example a share in, or bet on, an individual company might be prohibited, but an ETF or spreadbet on a wide index of shares, or the exchange rate between two countries, may be OK - your activity is not going to be big enough to move the market, damage a client's interest, or be the result of inside information.

Hi bowlhead99,

the policy is very strict and clearly states that we are only allowed to use funds as vehicle for investing. It's clear that I won't ever be in possess of information (and money) to move the market but this is how the policy works unfortunately. So, no ETF, no CFD, no stocks, no future or options. Just funds.

That's the reason why I need to find funds that work as tracker and that are cheap so that I can actually invest in index but being compliant at the same time.
I opened a Fidelity ISA because they offer (apparently cheap and good) index tracker (but please share your opinion if you can).

bowlhead99 wrote: »

I would have thought that if you don't want to take investment risk with your spare money, and want it to be denominated in EUR, then the simplest solution is to put it into a EUR bank account, surely . With Eurozone interest rates where they are at the moment (base rate 0.050%) you are not going to earn any significant income off it so tax wouldn't be a problem. So you could use a bank account back home in the eurozone, or here in UK, or somewhere neutral like Gibraltar, Channel Islands or Isle of Man

If you don't mind a bit of investment risk, and some of this cash is not going to be needed for many years until you are back in the Eurozone, it would make sense to consider investment funds in your ISA that have a Euro focus on what they invest in. Of course, you may find that UK, US, Japan etc perform better than the Eurozone over the next decade and so it makes sense that any investment funds in your ISA are spread around geographically.

I already have an account in EUR (which is the one I used before moving to UK). I could move money to that account on a regular basis but then you still need to pay commission on the transfer (I have a Barclays acount here).

In addition to that, I would like to use a (relatively) quick solution in order to switch money from GBP to EUR only when a EUR strengthen is anticipated. Of course, you need to be right and that's where the FX risk come from but the idea is to move money between GBP and EUR cash fund when needed (by a given market forecast).

Basically, this is the overall context. Based on this, do you think it would be a good solution to rely on Fidelity cash funds or there are other solutions (given my company's constraint) that I can use instead (probably with other providers, since I still have to open an investment account, I just have an ISA with Fidelity).

Thanks for your help.

bowlhead99

the_learner wrote: »

the policy is very strict and clearly states that we are only allowed to use funds as vehicle for investing. It's clear that I won't ever be in possess of information (and money) to move the market but this is how the policy works unfortunately. So, no ETF, no CFD, no stocks, no future or options. Just funds.

That's the reason why I need to find funds that work as tracker and that are cheap so that I can actually invest in index but being compliant at the same time.

OK, you can invest in funds and not other instruments. That is quite common because it's very easy for the compliance department to deal with (they don't have to keep taking time out of their day to give staff permission for individual shares, or monitor lots of complex investments). But I assume there will not be any restriction that the type of funds you invest in have to 'work as trackers'. There are all sorts of actively managed funds which have different investment strategies. Tracking an index is just one strategy.

Most indexes are weighted to the biggest companies in the index. If you believe that weighting your investments to the biggest companies in that particular investment universe is the best way of spreading your risk, it may be a good option for you. It is certainly a way of getting low management fees, because the investment manager can set it up with minimal ongoing trading or monitoring and no investment decisions to make. But it will not necessarily always get you the best result for all markets - it just aims to get you a result close to the underlying index. Personally, I don't always aim to get the same result as the index.

So, don't confuse needing to invest in a fund, with needing to invest in a tracker. The choice to use a tracker, instead of a different type of fund, is up to you.

I opened a Fidelity ISA because they offer (apparently cheap and good) index tracker (but please share your opinion if you can).

There are plenty of cheap and good index trackers. There is nothing terribly bad about the Fidelity one - they have recently reduced the management fee on it, so it should be able to track the index more closely than it did a few years ago. You don't need to hold your ISA with Fidelity to be able to invest in the Fidelity index trackers or any other funds - most platforms give you 2000+ investment options which will include Fidelity funds and HSBC funds and Vanguard funds etc etc.

As a platform for holding lots of funds, Fidelity doesn't seem too bad and several people on this forum use it. However, the ongoing platform fees are a bit higher than the cheapest you could find if you shopped around. Of course, whether you're paying 0.35% p.a. or 0.25% p.a. doesn't make much difference when your assets are just one or two years of ISA allowance.

I already have an account in EUR (which is the one I used before moving to UK). I could move money to that account on a regular basis but then you still need to pay commission on the transfer (I have a Barclays acount here).

In addition to that, I would like to use a (relatively) quick solution in order to switch money from GBP to EUR only when a EUR strengthen is anticipated. Of course, you need to be right and that's where the FX risk come from but the idea is to move money between GBP and EUR cash fund when needed (by a given market forecast).

So it sounds like you are really not concerned with using investment products to make long-term returns and beat inflation, you are more concerned with your currency exposure and you want to be able to simply hold cash but flip back and forth between currencies in line with your forecast of rates change.

It is difficult to do this, because all the information that everyone in the market has available to them, is what is creating today's exchange rate. If everyone thought that the EUR / GBP rate would be 1.20 by December, then they would all be buying EUR right now so that the rate became 1.20 today! All the forward rates reflect the interest rates on both currencies and market expectations of how those might change. So really you are only speculating based on which individual economists and market commentators you choose to believe, or what your own instinct (or your world economic financial model on a very complicated spreadsheet...) tells you is going to happen.

But setting that aside:

If the amounts you are doing this with are large (thousands instead of hundreds), then you can find FX brokers who will charge a commission on the transfer but give you a better rate / lower commission than your regular bank. Don't be misled that if you invest pounds into a foreign currency money market fund and then take it back to pounds again later, you will somehow avoid all commissions. The commissions may be low but it always costs money somewhere (compared to the pure mid-market interbank rate) to flip currencies. Plus, if you have to pay 0.4% all through every year you are holding this fund, as a platform fee, you have spend almost a percent after a couple of years anyway.

Basically, this is the overall context. Based on this, do you think it would be a good solution to rely on Fidelity cash funds or there are other solutions (given my company's constraint) that I can use instead (probably with other providers, since I still have to open an investment account, I just have an ISA with Fidelity).

Thanks for your help.

Personally, I wouldn't bother to create another investment account if I didn't want to invest, and only wanted to use FX facilities to move cash between currencies. If you forsee the rates changing significantly in favour of Euros (say, by 5 to 10% or more), and you believe your prediction will be accurate, then holding Euros instead of GBP is probably the right thing to do, and you should simply buy Euros. If it costs you 1-2% to do that via an FX broker or your bank, it is still better than suffering the 10% devaluation of GBP. You will not reduce the costs to 0% by using an investment platform.

If you do this off-platform, an advantage is that your cash doesn't have to be sitting on a platform earning zero interest waiting for the time to be right for a trade, and then waiting further between the time when you place the order to the next daily dealing point for the fund. You could keep your GBP from day to day in a current account paying high interest on the first £x of account balance (e.g. Nationwide or TSB at 5%, 4% at Lloyds, 3% at Santander), and then whenever you feel the time is right, place a spot trade with an fx broker to flip it to EUR and pay the proceeds to your UK or overseas Euro account.

the_learner

bowlhead99 wrote: »

...

Hi and thanks for your answer. It all make sense to me and I don't want to trade the FX market this way.

I just want an allowed and easy solution to manage my GBP cashflows and convert them to EUR when a big move is expected.

For example, I would have moved GBP to an EUR cash fund during these days since the Scottish referendum is increasing EURGBP volatility.
I would have switched to EUR fixing the EUR amount using the currrent 0.80 rate.

After the referendum the rate can be higher/lower and that would cause me a gain/loss if I move back to GBP.
But I could be happy with a 0.8 rate and decide not to move back to GBP if the rate goes lower.
After all, pre-referendum I was doing all my maths with the assumptiom that 1€=0.8£ so by doing the switch to EUR I actually fix this assumption.

If rate goes up... I will have less GBP but the same amount if EUR as before.
If rate goes down... I will have more GBP but the same amount of EUR as before.

This is just to explain how I would use this funds. Not pure trading but more like hedging when big moves are expected.

the_learner

Hi, I have a question about funds that invest in US markets and are GBP denominated.

For example, Fidelity has a S&P500 tracker Fidelity Index US Fund P-Acc (GB00BJS8SH10). Its price is in GBP so I am wondering if there is no FX risk involved in this position.

Is it a FX-hedged position or not? And how does this affect the replication of the index?

For example, suppose that I invest £1000 in this fund. The S&P500 goes up by 3% but GBPUSD goes up by 2%.

The underlying security of the fund is in USD (it's the US index that they are replicating) but the price the fund in GBP.

So with my initial £1000 they buy me $1600 of the fund (suppose the initial GBPUSD is 1,6).
After the S&P500 rise the fund is worth $1648 (3% more).
My final position is in GBP so they will simply convert the $1648 to the new FX rate 1,632 (under the hypothesis of a 2% increase for GBPUSD)? Thus the position in GBP will be now worth £1009,80 with a 0,9% increase instead of the 3% they shoul replicate (which is the performance of S&P500).

This would be a poor tracker for a GBP investment.

Can you please clarify how the GBPUSD comes into play in this investment?

Thanks a lot.

bowlhead99

Here's some food for thought:

The US index might go up by 3% because Apple and Microsoft and General Motors go up by 3%. All of those companies will have earnings denominated in multiple currencies. Imagine GM was the only company in the index. General Motors would have some of its cashflows in EUR from selling Opels and AUD from selling Holdens and GBP from selling Vauxhalls. If dollar weakens, those overseas revenues are more valuable and people assessing the price of a GM share would value it at more dollars. GM as a $50bn company is going to help the overall index value in dollars go upwards.

Of course, to you as a non US investor, GM's non US revenues didn't necessarily change in their underlying currencies, so back in GBP or Euros you might not be valuing GM as a company any more than you valued it yesterday. The index might have gone up in USD terms because GM is worth $55bn instead of $50bn due to its better quality overseas revenues.

But from a GBP perspective - the GBP Vauxhall revenues aren't worth anything more to you than they were before, and the USD revenues are worth less to you than they were before because USD is weaker. So from your point of view GM is maybe only worth £28bn from £30bn before. The USD S&P 500 index goes up by 10% but your return when converting that back to pounds, if you didn't hedge, is closer to negative 10% than positive 10%.

The S&P index is priced in USD. So as a GBP investor, if the index is not hedged, it is possible for you to get a negative return when the index delivered a positive return. But that possibility by itself does not make it 'a poor tracker for a GBP investment'. It is a fine tracker because it successfully delivered the performance of GM cars, from the perspective of a UK investor. If you also held an unhedged Frankfurt index you would have the underlying performance of VW and Audi car brands too, from the perspective of a UK investor. Neither GM nor VW are UK listed or GBP priced but it doesn't mean you shouldn't hold either of them if you want exposure to the prospects of car manufacturers.

Generally if you buy an investment fund that is available to subscribe in GBP but is investing in overseas assets, it just means that at each valuation point they convert the values of the USD/EUR/JPY assets into GBP to tell you your GBP fair value. If the USD/EUR/JPY assets went up by 10% and GBP strengthened, you wouldn't actually have any more GBP fair value, despite the index climbing from the USD or EUR or JPY perspective. But you would have got the exact same results as if you went and bought the underlying shares in Apple and Facebook and Microsofit and GM and VW etc, so it would be a proper tracker.

If you are looking for a product that gives you 10% gain in GBP terms when a share index, or other actively managed basket of shares, goes up by 10% in USD, you are going to have to look for one that attempts to hedge. Most index funds do not, they just provide cheap exposure to the underlying assets in their raw form. Hedging is generally not 100% perfect and in any case has an implicit cost. If you're unclear about what a fund does, check with the fund manager. Or simply look at its returns against the underlying index and work out whether it was hedged or not.

If you invest purely in the UK indexes, you generally don't think about hedging because the return of your fund is whatever the index number says (less costs). However of course, BP and Royal Dutch Shell are selling their oil in USD and Unilever is selling its washing powder to the Greeks and the Chinese in EUR and RMB, so a change in fx rates will change the value of the index. You are perhaps not prompted to think that perhaps you should manually hedge your exposure to keep the 'pure' returns of those underlying company revenues.

IMHO, most people want the wide diversification that comes with holding an index or a basket of indexes and so are not driven to apply their own hedging. Ultimately if a USD index rises you end up with more dollars but maybe not more pounds. But when you buy anything from a US company for the rest of your life, the prices are driven by a USD cost base. So having dollar assets is a good thing and if you only focus on converting them back to pounds and what they mean in GBP, you are perhaps missing a trick.