Volatility has become the new norm in global markets. There have been historically high returns, but also historically large losses, over the last few years. Yes, there are the good old faithful, stable companies that have shown steady returns, but these seem fewer than before.
With controversial AI changing the modern investment landscape, volatility seems to go hand in hand with AI. Geopolitical tensions and events are also weakening global stability.
Diversification is the best hedge against volatile markets as it mitigates against risk and losses, but the modern question is: is it enough?
“Diversification across currencies, not just asset classes, is no longer optional,” – Nigel Green.
While asset allocation is vital for a diversified portfolio, currency diversification is becoming a necessary addition to hedge against global volatility.
This means that diversifying across asset classes, regions and sectors might not be enough anymore; currencies are important too.
Currency diversification is the strategy of holding investments, savings, or income in more than one currency instead of relying on a single one. The aim is to reduce the impact of exchange rate movements and protect purchasing power over the long term.
For people with international lifestyles—such as expatriates, global investors, or those planning to retire abroad—currency diversification can be an important part of financial planning.
Instead of having all your assets in one currency, you spread your exposure across several major currencies, such as:
This helps reduce the risk that a sharp fall in one currency significantly affects your overall wealth.
Example
Imagine a British couple planning to retire in Portugal.
If the pound weakens by 15% against the euro, their retirement income buys less in Portugal. However, if part of their portfolio is already held in euros or investments that benefit from a stronger euro, the impact can be reduced.
Currency diversification does not eliminate risk. Exchange rates can move in either direction, and holding multiple currencies may sometimes reduce returns if your home currency strengthens. It should be viewed as one element of a broader, diversified investment strategy rather than a way to generate higher returns.
An investment portfolio usually consists of various asset classes, including equities or stocks, bonds, and cash or cash derivatives, to name a few. When creating a financial portfolio, an investor or financial advisor decides on the amount of each asset class to invest in and allocates the assets accordingly. For example, an advisor allocates 60% equities or stocks, 30% bonds and 10% cash to a portfolio.
Asset allocation is a crucial strategy to ensure that a financial portfolio performs efficiently and delivers maximum returns in line with an investor’s financial needs.
The percentages of assets allocated could determine a portfolio’s profitability. Loading a portfolio with too many equities and not enough bonds could increase the risk of losses, which could be much higher in volatile markets, or have too high a bond concentration, and one could risk the possibility of low returns or even losing capital due to returns lower than inflation.
The percentages of various asset classes will determine the risk tolerance of an investor. Generally, a higher concentration of equities in a portfolio means higher risk and potentially higher returns. Bonds have a lower risk but also potentially lower returns. Each investor is comfortable with a specific risk profile or level of risk.
An investor with a more aggressive risk tolerance would have a higher concentration of equities or stocks and a low bond and cash concentration. This means more risk of losses but also potentially higher returns.
A more conservative investor would potentially have equal equities and bonds to preserve capital.
Asset class diversification is one of the best strategies to protect a portfolio against the risk of losses and market volatility. Different assets have different characteristics and risk levels. A portfolio is diversified against risk by choosing assets with different characteristics and assets that react differently to market volatility.
Asset class allocation is but one strategy of diversification; others include diversifying across various regions and various sectors.
For example, asset classes like equities and bonds can come from different regions (US, Europe, Asia, etc.) and sectors (Pharmaceuticals, Oil and energy, Financials, Tech, etc.) This adds an extra layer of diversification to protect a portfolio against market risk—basically, diversification within diversification.
Asset allocation can and will change over time due to various circumstances.
Over time, asset classes perform differently and offer different returns. If one asset class performs better over time, it will hold a heavier portion of the portfolio than initially intended, thus increasing risk. Rebalancing is required. A financial adviser would rebalance a portfolio (selling and buying assets) to return to the original asset weighting and risk level that the investor is comfortable with.
Leave asset allocation to the experts – If asset allocation seems daunting, don’t stress; let the qualified experts do it. Your financial adviser will allocate assets according to your risk profile. Also, many funds are already diversified into various asset classes, regions, and sectors for investors, which takes the stress out of investing. Qualified fund managers administer these funds and make investing decisions on the investor’s behalf.
This method of diversification spreads investments over sectors. Sectors or industries operate differently from each other and react differently to markets. Investments diversified across industries are less likely to be impacted by sector-specific risk.
This means holding investments from different regions. As an investor, you don’t want all your money in one country or region in case of failure. Spreading investments across various regions allows you to reduce portfolio risk by avoiding overconcentration in one area.
Regions include:
Some regions are more economically stable than others. The US and European economies are more reliable and historically stable, whilst emerging Asian, African and Latin American markets are still volatile.
For example, a portfolio that invests heavily in Asia may suffer significant losses if China or Japan were to enter a recession, whereas including the US and Europe would provide greater stability.
For internationally mobile investors, the question isn’t simply “Which investments should I own?” It’s also “Which currencies should my wealth be held in?” Balancing both investment diversification and currency diversification can help create a more resilient financial plan, particularly if your income, assets, and future spending are spread across different countries.
Please note, the above is for educational purposes only and does not constitute advice. You should always contact your adviser for a personal consultation.
* No liability can be accepted for any actions taken or refrained from being taken, as a result of reading the above.
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