A software vendor client of ours described a situation involving one of their clients. Until a certain date, the portfolio’s return was in US Dollars (USD). After that date, it was in Japanese Yen (JPY). The question: can we link these periodic returns?

My initial reaction was to distinguish between local and base returns. The local return is the return of the assets. For the initial period, my guess is that the portfolio was invested in USD denominated securities, so the local return was USD. And more recently, it appears the portfolio was invested in Japanese denominated securities, so the local return is JPY. To paraphrase my friend, Steve Campisi, you can’t eat local returns.

Further, as Denis Karnosky and Brian Singer wrote in their monograph, Global Asset Management and Performance Attribution, “Because of the unavoidable impact of interest rate differentials in controlling exchange rate exposures, local Eurodeposit returns are an inseparable component of currency returns.” I.e., investors cannot achieve local returns.

My initial reaction was that you wouldn’t want to link these different currency returns and that the investor should be more interested in their base return, which is reflected in their currency.

However, upon further reflection (which occurred in the wee hours of this morning, while attempting to remain asleep), I was once again reminded of the fundamental principle that one should always keep in mind when discussing returns: what’s the question? That is, what question does the investor wish to get an answer to?

If they’re interested in how the manager(s) performed at the local currency level, before the impact of currency movements (as well as any hedging which may have been employed) is taken into consideration, then to link these returns is fine. We often mix different currencies together to obtain our local return, so to link them is acceptable. The why behind the question (that is, why would they want to know this?) may have value, perhaps at a minimum from an academic perspective, but in the end, if the client asks that the two period returns be linked, this is okay. But again, “what are they hoping to gain from this information?” is a valid point to raise.