Andrew Hallam
21.11.22
Investors in ETFs: How Much Do You Know About Currency Risk and Performance?
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Here’s a pop quiz. I’m going to ask five questions. Each of them reflects what plenty of investors have asked me over the past several years. Knowing these answers (or learning them now) increases the odds that you’ll make more money. After all, when it comes to investing, knowledge really is power. After answering all five questions, you can see the answers at the end.
Scenario
Katy and Miranda are British expats living in Luxembourg. They both earn incomes in Euros. On November 1, 2021, Katy converted €10,000 into British pounds. She invested the proceeds in Vanguard’s S&P 500 UCITS ETF (VUSA). It trades on the London Stock Exchange. It’s priced in pounds. According to Morningstar UK, from November 1, 2021 to October 31, 2022, it dropped 3.4 percent. Like Katy, Miranda also wanted to invest in the S&P 500: a compilation of 500 of America’s largest stocks. She converted €10,000 to USD and purchased the iShares Core S&P 500 ETF (IVV). According to Morningstar, from November 1, 2021 to October 31, 2022 it dropped 15.50 percent.
Question 1
If, on October 31st 2022, they each took their proceeds and converted them back to Euros, who would have the most money?
A. Katy would have more because her ETF dropped 3.4 percent. Miranda’s dropped 15.50 percent.
B. Miranda and Katy would have roughly the same amount of money.
C. Miranda would have more because the Euro fell a lot, compared to the USD.
Scenario
Jimmy and Johnny each earn very small incomes. They decide to save some cash so they could purchase some ETFs at the end of the 2020. Jimmy put his cash in an Indian savings account, in rupees. He earned 6 percent interest. Jimmy put his savings in a US dollar savings account. He earned 0.20 percent interest for the year.
Question 2
If they converted their proceeds into a different currency (any currency) which of them would have more money?
A. Jimmy because he earned 6 percent.
B. It would depend on how each currency performed, relative to each other, over that time period.
C. None of the above
Question 3
If someone gave $10,000 USD to all of America’s stock market traders on January 1, 1990, it would have grown to about $205,601 by October 31, 2022 if they only bought US shares and no fees were charged (ie. no commissions for trades). If, on the other hand, someone gave $10,000 USD to all of the world’s currency traders on January 1, 1990 which of the amounts below would be closest to what they would have on October 31, 2022.
A. Between $100,000 and $200,000.
B. About $10,000
C. Between $50,000 and $90,000
Question 4
Elizabeth earns her income in Australian dollars. She invests monthly in a globally diversified portfolio of ETFs: 60 percent global stocks and 40 percent global bonds. Her ETFs are priced in USD. For the past year, the USD has gained much ground on the Australian dollar. Assume global stocks and global bonds didn’t record a gain or a loss over the past year.
Did Elizabeth…
A. …have reduced buying (investment) power because the Australian dollar dropped compared to the USD (her ETFs are listed in USD)?
B. …have about the same buying (investment) power because the entities she is buying (global stocks and global bonds) represent multiple currencies, not just USD?
C. …have increased buying (investment) power because the Australian dollar dropped compared to the USD?
Question 5
Vanguard’s US Stock Market Index ETF (VTI) trades in USD on the New York Stock Exchange. As I write, it’s trading at $193 USD per share. Vanguard’s US Stock Market Index ETF (VUN) trades on the Toronto Stock Exchange in Canadian dollars. As I write, it’s trading at $71 Canadian per share. Which of the following statements is true?
A. Because the Canadian dollar is worth less than the US dollar, anyone buying the Canadian dollar version gets a better price.
B. Whether investors pay $71 Canadian or $193 USD doesn’t matter because they are buying the same investment at the same price.
C. Because the US dollar is stronger than the Canadian dollar, anyone buying the index in US dollars is getting a better price.
The answers
To score 5/5, you needed to answer, “B” for every question.
Question 1 Answer:
B. Miranda and Katy would have roughly the same amount of money.
This trips up plenty of investors. They might see two ETFs that track the same market. But one posts a significantly different past return. In that case, check the currency they’re listed in and understand that the perceived performance difference is purely a mirage. In the example provided, Vanguard’s S&P 500 UCITS ETF (VUSA) dropped just 3.4 percent from January 1st to October 31, 2022.
The iShares Core S&P 500 ETF (IVV) dropped a whopping 15.5 percent over the same time period.
But the first ETF trades in British pounds with the second trading in USD. When two ETFs track exactly the same index, they will earn very similar (often identical) returns. Full stop. The different currencies, however, create a mirage. In this case, the US dollar rose strongly against the British pound. That makes the ETF that was denominated in British pounds look like the better performer. But if the proceeds were converted into a constant currency (any currency) the amount would be the same.
Question 2 Answer:
B. It would depend on how each currency performed, relative to each other, over that time period.
If we put money in a savings account that earns 6 percent in one currency, it hasn’t necessarily outperformed another savings account that earned, say, 0.25 percent in a different currency. Much depends on how the two currencies compared.
Emerging market currencies tend to be volatile. That’s one reason emerging market banks offer higher savings interest rates. But if that currency sinks against a basket of global currencies, the investor in that currency might not have come out ahead.
In the example provided, where an investor earned 6 percent in rupees, someone who earned 0.25 percent in USD would have made more money over the 12 months ending November 2, 2022. That’s because the US dollar gains about 12 percent on the rupee over that 12 month period.
Question 3 Answer:
B. About $10,000
As a group, stocks rise. Real estate rises. But currencies do not. That’s why currency trading is called a “zero sum game.” For every winner in a currency trade, there is always an equal and opposite loser. That’s why (unlike with stocks and real estate) the aggregate return of every currency trader in the world will be zero. As a result, if you gave $10,000 to all of the world’s currency traders in 1990, no matter what they did, the typical currency trader would have $10,000 by 2022. Some would have more; some would have less. But as a group, they would have the same amount (on average) because currency trading is a zero sum game.
Question 4 Answer:
B. Elizabeth would have about the same buying (investment) power because the entities she is buying (global stocks and global bonds) represent multiple currencies, not just USD.
That’s why the recent drop in the Australian dollar (the currency she earns her income in) wouldn’t mean Elizabeth is getting a raw deal when she converts her money into USD to buy her global stock index. For example, a global stock index comprises stocks priced in multiple currencies. Some are US stocks, price in US dollars. But plenty are European shares, Canadian shares, Brazilian shares, New Zealand shares, Swedish shares, Swiss shares. If the Australian dollar dropped far more than these other currencies, combined, then she would be getting less for her money. But in 2021/2022, that was not the case.
Question 5 Answer:
B. Whether investors pay $71 Canadian or $193 USD for a US stock market ETF doesn’t matter because they are buying the same investment at the same price. The currency that it’s priced in is irrelevant. What’s also irrelevant are how many pieces the pizza is sliced into. For example, assume a pizza costs $10. It has 5 slices. Those slices are $2 each.
That pizza would cost the sam if it were divided into just 2 slices, at $5 each.
The price differences and the listed currencies are simply just mirages.
Andrew Hallam is a Digital Nomad. He’s the bestselling author Balance: How to Invest and Spend for Happiness, Health and Wealth. He also wrote Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas
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Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.