Currency fluctuations are a critical external factor impacting the performance of multinational companies within the FTSE 100. The index, a barometer of the UK's largest publicly traded companies, is inherently sensitive to changes in exchange rates because many of its constituents earn a significant portion of their revenues outside the UK. This article explores the effects of currency fluctuations on these companies, examines the relationship between the British pound's strength and the FTSE 100's performance, and offers strategies for managing currency risk in an investment portfolio.
CURRENCY FLUCTUATIONS AND MULTINATIONAL COMPANIES
For multinational companies in the FTSE 100, exchange rate movements can have profound impacts on financial outcomes. When the British pound strengthens against other currencies, revenues earned abroad in foreign currencies translate into fewer pounds, potentially reducing reported earnings and impacting stock prices. Conversely, a weaker pound can enhance the sterling value of foreign revenues, boosting earnings without any change in the underlying business performance.
This dynamic plays out across various sectors, from pharmaceuticals and consumer goods to energy and technology, affecting companies like AstraZeneca, Unilever, BP and Sage Group. For instance, a global pharmaceutical company earning substantial revenues in the US dollar will see its sterling-reported earnings fluctuate with the GBP/USD exchange rate.
THE POUND'S STRENGTH AND THE FTSE 100'S PERFORMANCE
The relationship between the British pound's strength and the FTSE 100's performance is inversely correlated. A strong pound typically signals reduced competitiveness for UK exports and lower sterling values for overseas earnings, which can weigh on the index. On the other hand, a weak pound can be beneficial for the FTSE 100. Many of its constituents, earning revenues in stronger currencies, report higher earnings in pound terms, often leading to a rise in their stock prices and, by extension, the index.
This inverse relationship was notably evident in the aftermath of the Brexit referendum in 2016, when the pound's significant depreciation led to a rally in the FTSE 100. Investors saw this as an immediate benefit to multinational companies' earnings within the index, driving up stock prices despite broader economic uncertainties.
MANAGING CURRENCY RISK IN AN INVESTMENT PORTFOLIO
For investors, understanding and managing currency risk is vital in investing in a globally exposed index like the FTSE 100. Here are several strategies to consider:
Hedging: Investors can use financial instruments like futures, options or forward contracts to hedge against undesirable currency movements. By locking in exchange rates for future dates, investors can mitigate the risk of adverse currency fluctuations impacting their investment returns.
Diversification: Building a geographically diversified portfolio can also help manage currency risk. By spreading investments across different regions and currencies, investors can offset losses in one area with gains in another, reducing the overall impact of currency movements on their portfolio.
Currency-neutral funds: Investing in currency-neutral funds or ETFs that hedge currency risk can be another effective strategy. These funds aim to neutralise the impact of currency movements, allowing investors to focus on the underlying assets' performance without worrying about exchange rate fluctuations.
Monitoring and rebalancing: Regularly monitoring currency exposures and rebalancing the portfolio can help manage risks. Investors should be aware of their portfolio's currency composition and adjust their holdings as needed to align with their risk tolerance and investment objectives.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.