Tuesday, November 13, 2007

Effect of Exchange Rate Fluctuations on Returns

My recent net worth reports have shown huge fluctuations due to the volatility in the Australian Dollar-US Dollar exchange rate. Returns are strong in US Dollar terms when the Australian Dollar is rising - even though this is making us poorer in Australian Dollar terms. Each month I calculate the contribution to investment returns from the change in exchange rates under the heading "Forex" in my income and expenditure table and my table of returns on individual investments. In the last few days the Aussie has plummeted resulting in strongly negative investment returns for the month to date. This table shows just how much difference changes in the exchange rate make:

Stripping out the exchange rate results in lower average returns for the year so far (12.8% vs. 20.7%) but greatly lowered volatility and hence a higher Sharpe Ratio, which is a measure of the excess return (above a 5% hurdle in this case) divided by the standard deviation of returns. Both Sharpe Ratios exceed those for the MSCI and SPX total return indices. The SPX has risen less than the 5% hurdle so far this year (3.1%) and thus has a negative Sharpe Ratio. The MSCI has returned 12.8% at this point. A large part of that return is due to the fall in the US dollar. This is a global index measured in US Dollar terms. So really I'm doing neither as good, nor as bad as it might seem. I'm probably really beating the MSCI but not by as much as the crude numbers suggest. I've had two negative months - but both have come in the second half of the year, which has made me feel a bit despondent but the two indices have had four or five negative months.

Here is the same data for the more visually oriented:

BTW I haven't seen any comments in the personal finance blogosphere (obviously there's plenty on trading blogs) so far about this month's so far sharp fall in the indices. I guess it will come soon.

Following up from yesterday's blog. Actually, the model has been doing fine this month so far with only one stop-out so far (Friday). But I've been scared to get back on board due to its poor performance from the beginning of September to 2/3 the way through October. There were heaps of stop outs in late July and early August too. I wish there were a futures contract smaller even than the NQ (NASDAQ E-Mini) and I would be trading it overnight my time (US day time).


Anonymous said...

Could you please add a RSS link to your blog? Thanks!

mOOm said...

RSS is enabled. With Google Reader you just paste this in:


I use Safari on Mac OS X and there is a little RSS button in the address window - you click that and get the URL above. Should I put this linked to a button for other browsers/OS's?