Change for the Better

Barack Obama made change the focus of his campaign. Change should also be the focus of investors; but we are talking about a very specific type of change: currency exchange. It is one of the important principles of diversification that a portfolio should contain assets from different world regions. Europe, North America, Asia, and the emerging markets are the regions that are typically recommended for inclusion in every well balanced portfolio. However, many securities are not available in the investor’s local currency. In consequence, most investors face the necessity of buying securities with foreign currency and the need to exchange their domestic currency from time to time. We have heard from several investors that this can become a very expensive exercise if one is not aware of potential pitfalls. For example, in the MyPrivateBanking.com group discussions a member writes:

“Have a close look on the exchange rates your WM charges when changing currencies. I know from my WM that the bank charges 1.5% for such a transaction! This is crazy. In particular, after complaining, they cut it to half. And after insisting on getting an extra discount for changing a higher amount (200k) I got 0.3%.”

Another member writes that he was able to get even a better deal from his private bank: “I pay 10 basis points on transactions over $20K with a private bank.”

The examples quoted here show that your exchange rate can make a lot of difference to the performance of your overall portfolio. For instance, if you invest one third of your portfolio in products only purchasable in foreign currency, assuming your average cost for the exchange is 100 basis points (1.00%) and your average holding period for a product is two years, you will lower your overall performance by 30 to 40 basis points per year. This calculation assumes that you exchange local currency for foreign currency whenever you buy and sell the product. Losing 30 to 40 basis points for 10 years would lead to a drag on performance of approximately 5% over this period compared to investing only in securities denominated in your local currency.

There are a few things every private investor should know about foreign exchange:

• Before you make a foreign currency transaction, check the real time market rate on the Internet. Yahoo Finance or other portals give you an easy set of tools to get the most up-to-date market rate on almost any important currency pair.
  

• Beware of automatic currency exchange when you do an online or telephone trade with your bank or broker. They might just convert money from your dealing account to buy foreign assets at the so called “system rate”, which is usually the worst on offer from your bank.
  

• Negotiate your exchange rate: make sure that you get preferential treatment, an improvement on the system rate, when you want to change small amounts quickly online. Be even more insistent on preferential rates for any amount higher than USD 10,000. You should be able to negotiate a rate between 10 and 40 basis points better than the market rate.
  

• If you can’t get what you want from your main wealth manager, don’t hesitate to switch to special platforms to get a better exchange rate. In most countries you will find online brokers who offer extremely competitive deals on foreign currency – especially if you make frequent trades for substantial amounts.
  

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