The Brexit-inspired slump in sterling could be a warning sign for UK investors with too much exposure to the domestic currency, according to Charles Schwab’s Richard Flynn. 
While it is often argued that UK investors have too much domestic equity exposure, currency is rarely given too much thought.
However, it should rank alongside security selection as one of the building blocks of portfolio construction, according to Flynn.
As the below chart shows, since the 2016 referendum sterling has fallen by 11.14 per cent compared with the US dollar.
Performance of sterling in US dollar terms since EU referendum
Source: FE Analytics
“The big thing for UK investors – and the story that I think hasn’t really been told – is that there is a significant home bias in the UK,” said Flynn.
“A lot of UK investors will stick to pound, investing in the FTSE and sticking to UK funds.”
This is a big mistake, according to Flynn – UK managing director at the US investment firm – who believes that diversifying currency in a portfolio is the best way to de-risk against the persistently volatile global macro picture.
Flynn explained: “We feel that over the last few years, in particular, a lot of investors who have unfortunately seen the downside of currencies have experienced that because they have been heavily invested in just one currency.”
As can be expected, Flynn’s best alternative currency for UK investors is the US dollar.
The US may appear an odd place to turn to for currency diversification as it is currently in a prolonged trade war with China, a politically economic battle which Flynn himself admits can and will have an impact on other currencies.
“Currency also has a role in terms of the tariff discussion and the trade war,” he said. “A lot of countries are looking to devalue their currencies in different ways.
“China has a significant amount of ammunition in a currency war but less ammunition in a trade war, because of the trade balance with the US.”
Even though Flynn admits that this will be a “very interesting” time for the US dollar he maintains that it is one of the opportunities investors should be considering.
“If you’re sufficiently diversified, it shouldn’t matter what’s going on in the UK on its own, or what’s going on in the US,” the Charles Schwab managing director explained. “If you’re diversified with a global portfolio, if you’ve got exposure to different currencies, the relative performance of a particular country or currency shouldn’t massively impact you on the downside.
“It’s a pretty dull idea, unfortunately, but we like it.”
This more boring investment approach is the hallmark of Schwab’s overall investment style, Flynn explained, adding that they view investment ideas through their clients’ eyes and perspective to see what is the best opportunity for them.
This is particularly important when it comes to risk, he said, and making sure that you do not fall into more “emotional investing”.
“Risk is a really important thing to manage,” Flynn (pictured) said: “It’s just as important to manage if you’re 23 or 68.
“Yeah, they’re just two different risk portfolios but it’s the same fundamental thing, you’ve got to recognise what you’re able to accept in terms of risk.”
Emotional reactions should be unnecessary, he said, since you invest with a knowledge that the market has volatility in some form continuously and should be able to cushion yourself against short-term setbacks and not make rash decisions.
However, the long-term investment mindset is something which is being lost amongst the noise of market volatility, he said, and is becoming increasingly hard to instil into investors nowadays.
“There’s a tendency in this modern world for people to be a little impatient,” he said. “And in investing, that can be quite a dangerous thing.”
‘Short-termism’ has led to a drop-off in investors maintaining long-term positions, but fast returns are not compatible with economic policies that can take months to materialise and affect markets.
This he said had recently been a factor that has increased as market uncertainty and volatility has risen, fuelled by situations such as the Federal Reserve’s rate cut.
But Flynn pointed out that, the market can only handle so many different elements at once, and everyone is assuming that it will handle them all immediately.
He said: “There is something that’s really underpinned a lot of economic decision making over the last few years: that people believe the market has priced everything into it naturally and just does it whether that’s possible or not.
“I mean, a simple comment from Trump is meant to be able to push the market so heavily that the market doesn’t discount the fact that he might not be telling the truth.”
This pattern of short-term, reactive investment is not needed if investors have actively managed their portfolio risk and maintained diversification.
He said: “In terms of your own assessment of how much risk you can tolerate, there are periods when people that emotions get better, whether it’s fear or greed.
“So what we always try and say to people is, ‘look, you’ve got to be quite pragmatic about how you assess risk in your portfolio.’”
In addition, investors have to constantly realign holdings to meet their desired risk level, which is especially important in periods of higher volatility.
“Even just letting it go for six months, it’s very easy to find yourself with significantly higher exposure to market risk than you should be comfortable with,” he said.
“So we talk about currency for UK investors in particular, but for all our clients – whether they’re very aggressive or very cautious – what we really try and hammer home is that continuous monitoring of portfolios in these periods of uncertainty.
“Looking at the last 10 years, if you had a portfolio that was 50 per cent, stocks, and 50 per cent bonds and you never did anything, you’re probably operating at like 80-20 now, just by the nature of how the markets perform.”