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Currency Impacts Are Huge When It Comes to Investment Returns

by: Index Universe August 17, 2008 | about stocks: EEM / EFA / EZU / UDN / UUP    
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By Matthew Hougan

If Jim Wiandt is right about the dollar, and I think he is, the impact on investors will be huge.

The falling dollar has played an enormous role in the strong returns we've all enjoyed on our international equity investments recently. How big?

The table below compares the returns of the MSCI EAFE Index—the leading index of international, developed market equities—depending on whether you invested in dollars or in the local currency. 

MSCI EAFE Returns Comparison - U.S. Dollar Investor vs. Local Currency Investor
 

YTD

2007

2006

3-Yr

5-Yr

10-Yr

U.S. Dollar Returns

-13.82

11.17

26.34

10.5

15.36

5.38

Local Returns

-19.06

1.17

13.81

2.14

7.26

0.21

Source: Morningstar. Data as of July 31, 2008.

Vive la difference!

U.S. investors enjoyed an 11.2% return in 2007, for instance, while local investors limped along with a paltry 1.2% rise. In 2006, the dollar return nearly doubled the local currency return, 26.3% vs. 13.8%. On a three-year annualized basis, U.S. investors earned a hefty 10.5% return, while local markets showed just a 2.1% result.

The results are slightly less pronounced, but still important, when you look at emerging markets. Using the MSCI Emerging Markets Index as a proxy, on a 3-year basis, the falling dollar contributed about 4% annually to returns. 

MSCI Emerging Markets Returns Comparison - U.S. Dollar Investor vs. Local Currency Investor
 

YTD

2007

2006

3-Yr

5-Yr

10-Yr

U.S. Dollar Returns

-16.36

36.48

29.18

20.02

24.19

11.88

Local Returns

-18.10

30.40

25.57

16.17

19.71

11.93

Source: Morningstar. Data as of July 31, 2008.

Since we're talking about the euro specifically, I thought I'd show that too. The results are most startling: The euro's gains made up 10.5% of the 13.9% return on the MSCI Europe Index last year, as well as 17.8% of the 33.7% return in 2006. 

Nothing makes the case more clearly than the 3-year return: While European investors limped along with less than a 1% return, U.S. investors enjoyed an 11.1% boost. On the same stocks! The only difference is the currency. 

MSCI Europe Returns Comparison - U.S. Dollar Investor vs. Local Currency Investor
 

YTD

2007

2006

3-Yr

5-Yr

10-Yr

U.S. Dollar Returns

-14.93

13.86

33.72

11.14

16

5.08

Local Returns

-20.52

3.33

15.94

0.99

6.68

-0.23

Source: Morningstar. Data as of July 31, 2008.

If the dollar reverses, all these numbers will work in the opposite direction: U.S. investors with substantial allocations overseas will feel a major hit.

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This article has 3 comments:

  •  
    Aug 17 10:31 AM
    Sadly, many a mutual fund investor will have scanned the return tables, spotted the outperformance of the global and international funds, and allocated substantial portions of the portfolio to them. With the Euro in particular having cracked, performance chasing once again will come to grief at the cold cruel hands of mean reversion.
    Reply
  •  
    Aug 17 10:42 PM
    The author is totally missing the point.
    Global US dollar returns were almost identical for a reason, no one can even change that. To think about a company in global business, it doesn't really matter where it is listed, its value in USD will be the same.
    Based on that, we will keep seeing the investment returns the same in USD terms, therefore, with the rebounding dollar against Euro, the US index will be a loser compared to the index in Eurozone.
    Reply
  •  
    Aug 19 08:54 AM
    The currency impacts are definitely huge. Consider the South African gold miners -they sell gold in dollars and pay their bills in Rand. That spread is enormously profitable.

    I would argue that the bulk of foreign returns (in USD terms) can be explained almost completely by a depreciation of the dollar NOT by outperformance in earnings in foreign markets. And as the dollar strengthens the vast proportion of performance in the emerging markets will be lower than the US markets.
    Reply
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