Gold Investor - SPDR Gold Shares

The role of currencies in internationalportfolio managementForeign-exchange is a key area of focus within portfolio riskmanagement due to the fact that international allocation asa source of diversification has become a well-establishedpractice – especially after the 1970s and the adoption of modernportfolio theory. But every foreign investment exposes aninvestor to exchange-rate risk – whether large or small. 8In the 1990s, international diversification began to incorporateemerging markets alongside the more traditional developedmarkets. The trend toward global portfolios led to a drop indomestic equity bias among developed-market investorsbetween 1997 and 2010, from 78% to 48%. 9 From anexchange-rate perspective, allocation to assets denominatedoutside the major currencies – namely the US dollar, euro,pound sterling, Swiss franc and Japanese yen – albeit still small,doubled between 2002 and 2011. 10 Emerging markets havebeen beneficiaries of internationalisation over the last decade.A number of reasons underlie this trend including better growthopportunities, access to new products and new markets, andincreased issuance of government and corporate bonds. Inaddition, the lack of opportunities in developed markets, dueto low sovereign and corporate bond yields, lower potentialeconomic growth, downgraded risks from high indebtednessand debt-service ratios, are enhancing the appeal ofemerging markets.The benefits of international investment should be viewedagainst the backdrop of the risks. In fact, currencies, especiallyduring crises, have the potential to fall sharply over short periodsof time. For example, the Brazilian real depreciated by 53% in2002, converting a 1.5% local equity gain into a 33.7% loss forunhedged US dollar based investors. In 2008, the real fell oncemore against the US dollar, this time by 33%.8 This even includes currencies that are officially pegged to the investor’s own domestic currency. There is a non-quantifiable politically-derivedrisk that a peg is adjusted or removed.9 MSCI Barra, Global Equity Allocation, March 2012.10 IMF CPIS database. Currency allocations outside the majors have grown from an average of 3.4% to 6.5% in the last 10 years for investorsfrom the US, Europe, Switzerland and Japan.16_17