Portfolio development and design is ultimately the combination of various asset classes. The goal is to reach a targeted risk level and achieve a desired return. Within portfolios, international investments play a role to help broaden return opportunities and attempt to mitigate overall portfolio volatility.
Much like domestic investments, total returns are a combination of income and appreciation. However, international investments are impacted by a third component… currency changes. In other words, the rise or decline of the U.S. Dollar, relative to other currencies, influences international investment returns.
In general, the movement of the U.S. Dollar has an inverse impact on international investments. For example, a rising U.S. Dollar will have a negative impact on international returns. The accompanying chart attempts to illustrate this inverse nature. (Colored blocks have been added to help distinguish between Dollar movements.) The inverse relationship holds true most of the time. Only a short period in 2019 is when this relationship didn’t hold. (See the red block)
Why is this important? The U.S. Dollar is seen as a safe haven. When troubles arise or uncertainty appears, investors tend to flock towards safer and more secure assets. This often means investors purchasing U.S. Treasury bonds, which is a direct proxy for the U.S. Dollar. As calm is restored and confidence returns, investors tends to move away from safe haven assets towards riskier asset in an attempt to achieve higher returns.
In this COVID induced period, the U.S. Dollar initially experienced a rise. This was a product of the uncertainty being unleased on the world. As more was learned, measures were taken, uncertainty subsided, and the U.S. Dollar declined. Additionally, many foreign economies rebounded through the summer months contributing to their appeal. Both items contributed to the U.S. Dollar’s decline. The inverse relationship, as mentioned above, assisted with the appreciation of international investments. As the COVID vaccines are adopted, it is a good bet that some semblance of normal life will return. As such, moving away from safe haven assets should have a positive impact on international investments.