Montreal, Canada

Risk level and currency factors are perhaps the two most important variables for an investor to determine prior to commencing a global investment portfolio. Sadly, most investors fail to determine their appropriate risk level and worse, fail at understanding what the wrong currency exposure can imply to long-term portfolio returns.

Over the course of seventeen years managing private and institutional assets, I’m convinced the worst mistake investors make is failing to understand the meaning of “currency risk.”

It’s amazing but many investors spend more time determining what currency exposure they want rather than focusing on what might happen if that currency gamble turns the wrong way. After all, currencies and commodities rank as the most volatile assets and investors can win big or lose their shirt quickly in these fast-pace markets.

Basically, if you earn and live mostly in U.S. dollars, for example, then speculating with most of your assets in foreign currencies might result in serious losses of your purchasing power. Of course, in retrospect this speculation would have been brilliant this decade because the dollar has tanked since late 2001. But timing is everything in life and if you bought foreign currencies in 1995 and needed those same funds in dollars five years later you would have lost more than 50% of your purchasing power when converted back into dollars.

From 1995 to 2001 the dollar posted big gains against most foreign currencies as the Clinton-Rubin years produced budget surpluses and a bull market in almost everything American, including technology stocks.

Since nobody can predict the future it makes sound investment sense to always maintain a diversified portfolio. This means holding a range of foreign currencies for the long-term and most especially, gold bullion. You should also hold growth-based investments like equities, hedge funds, managed futures and bonds. But if you’re about to launch a global growth portfolio then choosing a sensible investment program in your base currency is the first hurdle you’ll have to determine.

Here’s what I tell my prospective investors: If a dollar-based client approaches me and he’s truly worried about the long-term decline of the dollar (and who isn’t?) then I suggest having him purchase 10% in physical gold (coins, wafers) for currency insurance and perhaps another 10% into non-dollar foreign currencies – outside of the assets I’ll be managing for him. This way, he’s invested in a long-term non-dollar plan that won’t require me to trade his portfolio of securities if the dollar starts declining.

Now don’t get me wrong. The portfolios I manage today hold some gold, commodities and foreign currencies. And in the future they’ll probably hold much more of these hard assets. But we’re mostly in dollar-denominated investment products and I don’t want to start trading these securities every time the dollar declines or buy them back when it rallies. That’s not how I manage money. Trading means fees and fees are the cancer that erode your portfolios’ value.

A dollar or a EUR-based portfolio should achieve three important objectives: First, it should outpace inflation (CPI). Second, it should outpace the risk-free rate on cash, which is 3-month LIBOR plus 3% in my book or 3.50% right now for dollar accounts. And third, it should outpace the MSCI World Index over a five-year period.

You can also add a fourth variable such as outpacing the U.S. Dollar Index or a basket of major non-EUR currencies over a five-year period. What I’m striving to achieve is to protect my investors’ purchasing power in their base currency. I can’t possibly beat the EUR every year if I’m dollar-based or outpace oil, gold, stocks, etc. What I want to do is make sure the client doesn’t lose money in his base currency.

In my experience, it’s far more important to own the right asset allocation and mixture of securities than picking the highs and lows of the currency market. It’s almost impossible. If you’re considering a global growth portfolio then make sure your advisor is properly diversified across asset classes and currencies. But don’t breathe down his back every time the dollar declines because, at the end of the day, currency speculation will usually result in big losses – especially if your base or home currency is compromised.