Performance Perspectives Blog

Not reporting the impact of currency fluctuations on mutual fund returns because (a) you don’t have to and (b) because it can’t be done … considered

by | Jan 7, 2014

I often find the WSJ enlightening. Today provided a very insightful article by Chana R. Schoenberger (“Test Your Smarts … on Currency Effects”, page R5), where I learned that at least some fund analysts believe they cannot tell the impact of currency fluctuations on their returns. I was quite surprised to learn this. 

Ms. Schoenberger poses eight questions and provides the answers to each. And to the second (“How much do currency fluctuations contribute to mutual fund returns?”) we learn “Funds do not have to report how much of their performance is due to currency effects, and we actually can’t tell,” as reported by a senior fund analyst at Morningstar. 

Not reporting the impact of currency movement on returns because we “do not have to” seems to missing a huge opportunity to provide investors (as well as prospective investors) details on the impact of how currency movements contributed or detracted from the fund’s performance. To ignore this impact would suggest, perhaps, that the entire movement comes from the appreciation or depreciation of the underlying holdings (i.e., the stock picking and sector/country allocation skills of the investment team, which are typically assessed in the local market), which of course would be false. In addition, such reporting should benefit the firm’s management, to understand the sources of return, so that individuals are properly rewarded and credited.

But to report that you “can’t tell” seems to reflect a lack of awareness that there are methods available to separate the impact from currency movement. The Karnosky-Singer model, for example, bifurcates the currency effect into (1) the amount coming from the change in currency rates on the underlying securities and (2) the contribution from the use of currency forward contracts. A “naive” model is available that seems to work fine if the manager isn’t engaging in the use of currency derivatives. 

I consulted with a client this week on their attribution system; since they’re a global equity manager, they calculate currency effects. They very much wish to demonstrate the impact currency has on their client’s returns; and, they can. 

Tomorrow I’ll post some “key points” about attribution; one addresses this very topic.

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