Investment returns are being eaten up by exchange rates – is it time to change tack?

It’s been hard for investors to turn a blind eye to the US market for the past few decades. The returns from the states’ most popular index, the S&P 500, have averaged over 15% per year over the past 10 years, in terms of sterling. It’s also home to many of the most-discussed stocks on the market, including Nvidia, Microsoft, and Google parent-company Alphabet.

But this year, the tanking value of the US dollar has made a massive impact on what returns look like for UK investors. In dollars, the S&P 500 has returned 11.21% this year. But for UK investors, who typically get returns in terms of sterling, this growth shrinks to just 3.07%.

This leaves UK investors with a few options: They can sit tight, and see if currencies stabilise, they can take investments out of the US and place them elsewhere, or they invest in a way that eliminates the currency risk. 

Does currency usually play this big of a role?

In short, for equity investments with the US, no. Typically, the volatility of a currency has a much smaller impact on investment returns, especially when it comes to stocks and shares, since they can be pretty volatile themselves. If your investment is in something that is typically more stable, such as a treasury bond, then protecting against currency fluctuations is more common, because the currency changes can outweigh the changes in the actual investment.

This year, the dollar had its worst first half of the year in over half a century compared to the DXY, an index that measures the dollar against a basket of other currencies.* While there have been other eras where the dollar has had larger changes in value over a longer period, the significance here has been the quick drop.

However, for UK investors, what really matters is the price of the USD versus the sterling, not the price of the USD versus a whole basket of currencies. On 2 January, the first day markets were open this year, a pound was worth $1.24. By 2 September, a pound was worth $1.34, which is over an 8% increase in value. To put this in perspective, that’s just under what global funds have returned each year over the past two decades.** And in this case, we have four more months of 2025 to go.

Although the currency environment this year has become troublesome for UK investors, it’s not always the case. In the past decade, the S&P 500 rose 333% in terms of sterling and 282% in terms of US dollars. This means that a UK investor could have been better off with the same amount of money in the S&P 500 versus a US investor, depending on what kind of fund they were holding.

So just as the currency environment can be harmful to investments if the value of the pound is outstripping the other currency, it can also be a boost if the value of the pound is falling compared to the other currency. The past ten years saw the value of the US dollar rise closer to the pound. As this transition happened, it boosted the returns that UK investors got from US investments.

Staying invested without the currency risk

Just because there’s currency risk doesn’t mean that the US market is a bad place to be. But, if you want to stay in the US market without taking on the currency risk, those investments will often need to be hedged.

Currency hedging can be complicated, but in short, when you currency hedge an investment, you attempt to offset the risk of loss by taking out another investment that will likely move in the opposite direction. So, you’ll be eating into your returns a little bit, but reducing some of the risk.

How you approach this depends on how you like to invest. If you invest through funds, you can buy one that is automatically currency hedged. Some funds make it obvious, by putting the word hedge in the name, or simply a ‘H’. This will mean the product is fully hedged. If it isn’t obviously stated, you may be able to see by looking at the KIID document. You can find out more details about a fund by using AJ Bell’s fund screener tool. ETFs also offer a broad range of hedged products.

Funds might be hedged at the share class level, meaning that the investment is hedged to its customers, or it could use currency look-through hedging. This means that the underlying assets held in the portfolio are hedged, instead of at the end of the process when it’s passed on to the investor. For example, if a multi-asset fund invests in a US fund that is hedged but also invests in UK funds that aren’t hedged.

If you are an individual stock investor, the process to hedge investments can be more complex. Some platforms may allow you to purchase investments in the currency that it was originally listed in. For example, for a US company you hold that investment in dollars. Otherwise, the methods get quite complex and often aren't available through your typical investment platforms.

Waiting out the currency environment

Changes in the UK or in the US could easily shift the currency dynamics. The US has no doubt been volatile this year when it comes to monetary policy, and there’s a good chance this continues in the future. But, there’s also a chance that this volatility swings the other way, and the dollar gains back some value. This would in turn boost investments that weren’t currency hedged, and those that were hedged would miss out on the upswing.

The UK could have some bumps of its own. Depending on how markets receive the Budget on 26 November, that could have a major impact on the value of the pound. If the value of the pound sinks lower, this would put it closer again to the dollar, and those who have forgone a currency hedge could benefit in this case.

 Just like it’s hard to predict market movements, it’s difficult to predict where the currency will go. It depends on a lot of different factors, like inflation, interest rates, and other policy decisions. If this wasn’t enough, unexpected interference (like Trump’s attempted ousting of a Federal Reserve Board member) can further rock currency relationships.

If you are happy with this extra volatility within your investments, you can sit tight and see where it takes you. But if the risk of the markets is enough, considering a currency hedge can be a viable option.

Opting for other markets

The currency risk of the US market isn’t necessarily a unique issue. Investments in other countries with notoriously fluctuating currency prices have also been heavily impacted. For example, the Nikkei 225, Japan’s primary index, has gained 68% in terms of yen, and just 11% in terms of sterling across the past decade.

The only way to eliminate this risk is to invest only in the UK market, but this in turn sets up a bit of a concentration risk and can be limiting to investors. Alternatively, investors could turn to Europe, as the UK and EU’s central banks tend to stay more in line with each other than other governments, although this could change.

Ultimately, by investing abroad you will either be taking on some degree of currency risk or taking a small hit to your returns to protect from fluctuations. Sometimes, the amount that currency influences investments is negligible, but when it starts to create significant differences to returns, it’s worth keeping in mind.

*Research from Morgan Stanley

**Using IA global sector average