Discretionary Fund Management Service (DFMS)

1) What is the Discretionary Fund Management Service (DFMS)?

Ans: A service for those investors interested in investing via regular saving plans or lump sum contributions

DFMS helps you manage the large array of funds life insurance companies have made available to you by selecting funds according to your personal profile and objectives

Investment professionals, backed by a competent administration team, set up and regularly monitor your investment structure and the performance of the funds in which you invest.

Your investments will be rebalanced when necessary according to your risk profile and financial objectives. Locking in profits and minimizing downside moves without reacting to emotional biases is the key to success. Few succeed in this demanding function because they lack the resources or time to manage your investments professionally.

2) Why do I need DFMS? There are already managers for the funds in my portfolio

DFMS rebalances the holdings of your funds based on both individual fund performance as well as a determination of the optimum allocation for your personal needs. Example: a fund manager of a Japan Equity Fund might be doing a great job - but if Japan as a whole were a dangerous market DFMS would not include it in its selection. Most investors choose funds from a large list - their initial choices are often based on:
Previous performance
Familiarity with a provider
Knowledge of certain sectors

More often than not, there are no switches made by investors for years - and any switches that are made are based on emotion, greed, or trying to 'outsmart' the market. By placing fund selection and management decisions in the hands of an objective team of experts, your returns will be enhanced while reducing unnecessary risk wherever possible

3) How does DFMS manage my funds?
The biggest determinant of fund performance is asset allocation - weightings between equities, bonds, cash and alternative investments are key to our strategies. But we do not stop there - we scrutinize each fund regularly based on:
Fund manager's style and track record
Geographic weightings
Currency exposure
Fund turnover (how often do the underlying investments change?)
Volatility (how risky is the fund?)
Performance and risk versus similar funds
Costs
A database of funds is kept and updated regularly - based on this, personalized portfolios are created and monitored.

4) Is my portfolio actively managed?
Yes. We monitor each portfolio and take the necessary steps to maintain the correct balance.

5) How often does DFMS make changes to my portfolio?
There may be no changes within a three-month period, or there may be one each month, depending on the need. Changes are driven by clients' needs and market movements.

6) Does DFMS change a portfolio's asset allocation depending on market conditions?
Not necessarily. Each asset class is assigned a range within which it may move. We alter the actual percentage - within this range depending on macroeconomic and market conditions and prospects.

History has proven that maintaining a range of weightings within each asset class leads to better long-term returns.

Risk

Ah risk! Everyone seems to be an expert. We all talk about risk, discuss it, we think we own it. In fact our whole lives are bathed in a pool of risk. From the moment we are born (infant mortality rate) to how well we fare during our lives (chances of success) and, ultimately, how long we live, all depends on risk.
One would think that our understanding of risk should be pretty good, maybe even excellent. After all, it seems that in everything we do, risk has a role to play. Yet, sadly, this is not the case. Risk assessment remains a “black” art, to be understood and mastered by few.
So what is risk? Is it maturity versus immaturity, experience versus inexperience, OR even greed versus reason? It’s all of them plus more! One common thread running through these “definitions” is tolerance for the unexpected. And this is the definition that we will stick to.
An immense amount of work has been carried out in order to assess risk. Insurance companies thrive and depend on these types of calculations.
In all different facets of everyday life we as individuals are constantly calculating risk. Most of the time we are not even aware we are doing it – crossing the street, the speed at which we drive, how much we eat and drink (one for the road) etc. It’s all a risk calculation. One thing is certain – each and every individual has a unique way of calculating risk.
However, being a financial publication, we will now concentrate on the financial side of risk. Building on what was discussed above, financial risk is just another risk factor in the myriads that swamp our everyday lives. Come to think of it, it’s not even the most important one since it certainly isn’t life-threatening. Yet, if you ask around, about ones risk profile, the first thing they’ll mention is financial risk. They could be living on a volcano precipice or directly over the San Andreas Fault and yet that’s not what they’ll site first. Amazing! Why though?
Money: The king to end all Kings, the End to everything, THE goal. So what does this mean to people like us, in the financial community? It means one thing: in order to be successful in the long haul, we have to mitigate risk. Seems perfectly reasonable but alas, this is not always to everyone’s liking. Everyone seems to like the concept, and yet, when it comes to implementation they start to huff and puff: “My returns aren’t high enough” or our old favourite “My friend told me about this fund, it returned 15% in the last little while. My investments aren’t anywhere near those numbers”.
We started by saying that people in general don’t really understand risk. Further, people don’t really understand their own tolerance to risk. Everyone wants to make the maximum returns. Unfortunately not everyone comprehends that the old axiom “Risk versus Reward” holds true at all times. It is practically impossible to make gains that aren’t matched by possible losses of the same magnitude. All of us can confidently state that we would be very happy with a 15%/pa return on our investment. Would we, with the same confidence, say that we would be unfazed by a 15% loss? Some of you might rush to answer positively. However, please, reach deep inside yourselves and answer truthfully. The reality, more often then not, is that you would be furious and blame the financial manager as incompetent. It may very well be the case but it could also simply mean that you and your financial manager took on more risk than you were able to tolerate.
John (Jack) Bogle, one of the greatest investors of all time, even though not the most popular, once said:
“If you have trouble imagining a 20% loss in the markets, then you shouldn’t be in the markets”.
True indeed, if you are aiming for a 20% return.
The other side if the coin is Warren Buffet (no introduction required) whose investment strategy relied on two basic rules:
1. Don’t lose money and
2. Remember rule 1.
Both of these investors have been extremely successful. Which camp do you belong in?
We, as financial advisors, attempt through knowing our clients, to determine and assess their tolerance to risk. This information will allow us to tailor the investment portfolio to be within an acceptable risk envelope for each specific client. It is true that we’d rather err on the side of caution, at the risk of limiting risk and consequently returns. We do believe though that through this strategy, we are doing what’s best for the clients even though they might not immediately appreciate it. But we are confident that in time, they will.
We’d rather be called “too cautious” and “too risk averse” rather than loose money. Maybe that’s just simply not fashionable anymore but we are not in the fashion business!
We don’t mind being classified like that and in the long run you wouldn’t either!

Copyright© Wealth Management Solutions Inc. - January 2005
WHAT ARE YOU BEING SOLD?

Investors’ natural tendency is to want and expect big returns. Investment companies spend billions in advertising to lure prospects on board. They try to dazzle investors with recent impressive returns from funds. It is human nature that makes individual investors chase funds and strategies that have produced the best returns. We emphasize the past tense in “have produced”. There is nothing easier than hindsight to choose the best performing funds of the past and to advertise them.

Sadly, past returns are only a small part of what determine future performance. In equity funds past performance is not a reliable predictor of future results. If a fund does well in one year, it is possibly because its managers took some extra risks to do so, and eventually those risks will bite them and their investors. It can be just as misleading to focus on returns from the recent past, as it is to focus on a high annualized/average return when a “freak” year produced a performance that was much higher than the norm.

Some of the most respected invested professionals in the world have recently predicted negative to single-digit positive growth in almost all asset classes (equities, bonds, commodities, real estate) for 2005. They cited the lack of good values across the board in a world economy that is only growing at nominal rates.

What should you look for in a portfolio structure? We have identified 6 criteria you should be aware of when considering your portfolio manager:

1. Have you been sold on impressive PAST PERFORMANCE of underlying assets? Always question large double-digit gains of the past, as well as how selective these have been. Past performance is often worthless when it comes to trying to figure out the future. The best use of past performance is to determine how a manager behaved in a particular set of prior circumstances. The hold axiom “If it sounds too good to be true, it probably is” holds here.

2. Is it well DIVERSIFIED? Simple concept: spread the risk among different asset classes and while returns will be moderated, so will the downside. Diversification is a complicated process that involves proper evaluation of the investment sectors and determining the degree of potential correlation between them. It also involves determining the appropriate levels of investment in the various sectors as a direct consequence of a number of factors that are evaluated. The investor must insist that their portfolio manager understands proper portfolio strategies including diversification.


3. Do you understand the RISK involved? The manager must have a clear understanding of what the risk is and relate this to the investor in very clear terms, with both upside and downside outcomes. For example, a “balanced” portfolio will contain a balanced spread among asset classes. Private wealth managers such as Merrill Lynch and UBS generally allocate 40-60% in equities in a balanced portfolio. At WMS we tend to allocate less. Investors should not be confused with terms such as “cautious growth”. What does this mean?

4. Is the choice of assets INDEPENDENTLY chosen? Securities and funds must be chosen because the manager truly believes they are the best under the circumstances. It is highly unlikely that one fund family will satisfy most of a portfolio’s needs. We have seen time and again that for modest portfolios (of less than $1M) most portfolio managers tend to allocate a large part of the portfolio to in-house funds. A word of caution: when you spot the majority of your asset being placed in funds by the same company, be worried!

5. What is the COST of the chosen investments? In a low interest-rate/low return environment, portfolio costs should be kept to a minimum. As such, equity funds with high expense ratios should be avoided (funds-of-funds fall in this category). It is also common that small equity funds (with less than $10M under management) have higher expense ratios because some of the fund fees (as a percentage of total assets) are very high.

6. Is COST-AVERAGING being used? The manager must never buy large positions at the same time. In the same way he must never liquidate large positions at the same time. It is a disservice to the investor to make a clean sweep by selling all existing assets of a new portfolio at once, with no regard to prevailing market conditions, and in order to implement his own strategies immediately. It is also often a mistake not to hold enough cash to take advantage of unforeseen opportunities.

In conclusion portfolio management is a complex task that needs to balance good judgment about the future with equally sound risk management. It will be painful to investors if they let their human nature guide them solely in the direction of greed.

To quote from Bloomberg columnist Caroline Baum:
History repeats itself primarily because human nature doesn't change. On Wall Street, human nature is circumscribed by fear and greed. Among investors, fear seems to be a rare commodity these days.

Copyright© Wealth Management Solutions Inc. - January 2005

THE ART OF PORTFOLIO DIVERSIFICATION

What is Portfolio Diversification?

Portfolio diversification is a strategy whose primary aim is to reduce risk. This is accomplished by defining a portfolio strategy that encompasses diverse sectors and exposure levels and strives to achieve a balance so as to limit losses and thus achieve superior returns.
The theory behind proper portfolio diversification is that it is unlikely that all sectors in a given economic cycle will be affected the same way. Therefore, by designing a portfolio strategy whereby a number of different and relatively uncorrelated sectors are employed, the risk level of the portfolio as a whole is diminished.

Pitfalls:

It’s very important, when designing a strategy to make sure that seemingly uncorrelated sectors are not linked in any way; for example let’s assume that you select shipping as a sector and then energy. Well, they may seem uncorrelated but if the price of energy, say oil, goes up then the shipping sector may be negatively affected due to higher operating costs, which may have a negative impact on profit margins. This is just a crude example but you can see the underlying point.
At WMS, we, conduct extensive research and enforce proprietary procedures to define strategies that strive to achieve truly diversified portfolios. This involves a lot of in-depth analysis, determination of the degree of correlation, and continual re-evaluation and rebalancing of the strategies.

What does it take?

Efficient and effective portfolio diversification is directly proportional to the amount of money invested. The larger the amount the more effective diversification can be. This is not to say that a small portfolio cannot be diversified, but it limits the levels of risk reduction that we can achieve. We have determined through mathematical analysis and proven through empirical data that the minimum portfolio size that lends itself to proper diversification is circa $400,000 USD. We have established what we call the WMS Efficiency Ratio (WER).

We are not going to inundate you with our mathematical/statistical formulas here. It suffices to say that the WER is ultimately a calculated number that is derived from a number of criteria, empirical and otherwise. What we are looking for is the optimum portfolio size.
Applying the WER calculations, we have established that portfolios significantly smaller than $400,000 suffer excessively from a number of perils, purchase/maintenance charges being one of them, which inevitably negatively tax the various purchases that are required in order to have proper diversification and thus achieve the expected returns.
Anything above that number gradually increases the efficiency level of the portfolio (WER) and significantly improves both risk management and potential returns. We have found that portfolios in excess of $500,000 USD are at the optimal level.

Does it always work?

Yes. Portfolio diversification will always reduce the level of risk that a portfolio will be exposed to. The degree of success will vary with portfolio size, how severe the downturn in the overall economy is and numerous other factors. But the bottom line is that the level of risk of a diversified portfolio versus an undiversified one will be significantly less.

Side effects:

Like any hedging strategy, as one strives to reduce risk, there is an inevitable reduction in potential gains as well. The old axiom “risk/reward” is always at play: the more risk you take the higher the potential gains and the higher the possible losses. In order to skew odds our way, we employ a number of alternative investments that, through complicated strategies, manage to take advantage of market inefficiencies and swing better results with less risk.
WMS offers various levels or potential returns that can also be interpreted as levels of risk tolerance that the prospective investor is willing to accept.

Conclusion:

Portfolio diversification is one of a series of sound strategies employed by WMS in order to limit risk and safeguard our investors’ capital.
Diversification is a complicated process that involves proper evaluation of the investment sectors and determining the degree of potential correlation between them. It also involves determining the appropriate levels of investment in the various sectors as a direct product of a number of factors that we evaluate.
When one thinks of investing, one must insist that their portfolio manager understands proper portfolio strategies including diversification.

You will thank us for it!

Copyright© Wealth Management Solutions Inc. - January 2005
WITH A DASH OF FINANCE
Every one of us decides, at some point in our lives, that we should plan for the future. This usually involves some degree of financial planning. It is, unquestionably, very sound thinking and definitely a sign that we’ve reached an age of relative wisdom. We are usually motivated by a number of factors that vary from person to person – but one element is constant – our wish to plan.

Unfortunately, planning in general and financial planning in particular is not everyone’s forte. As a matter of fact planning itself is, for most people, a monumental task. It pays to have some basic knowledge of project planning, because at the end of the day, this is what it really is – a project.

So, what is a project? One definition is:
“A project is a fixed duration undertaking seeking to create a unique output”.

Translating this into our every-day language we arrive at:
“Our financial goal should have a fixed duration where we can measure results and thus determine whether our undertaking has succeeded or failed.”

We can break down our financial project into the following main areas:

• Cost – The cost, in this case, can be fees that we pay our financial advisor or other tangible and intangible charges to the project including the level of investment.
• Time – Our defined timeframe for our financial project
• Scope- A definition of what the expected results should be and what the investment boundaries, if any, are.
• Quality- A measure of the expected level of performance of the investment – this must be relative to acceptable benchmarks.

Be prepared to specify, at most, three out of the four parameters defined above. The fourth one will be a product of negotiation between the client and the project manager. If you are asking “Why three?” you should spend some time looking at the parameters and you will soon determine that the fourth (ANY fourth) can determine the other three! Try it!

Choosing a project manager is vital to the proper execution of any project. In the case of our financial project, it would be a Financial Advisor. Be prepared to state your expectations (above) to the project manager. Be also prepared to be turned down. A good project manager is the one that will only undertake a project if he/she determines that there is a fair expectation of success.

A vital element to agree with the project manager is the level of “auditing” of the ongoing project. This can be a trap for the client and lead to trouble for both the client and the manager. It is imperative that the duration is sufficiently analysed in order to determine appropriate audit points where a sound project assessment can be made. It is important to realise that linearity is not, necessarily, a project attribute i.e. if you are constructing a multi-storey building, you cannot expect to see the floors going up purely as a function of project time – architectural planning, equipment assembly time, material preparation, foundation etc. take precedent over “visible” building completion. For the longest time it might seem that nothing is happening!


The same applies to a financial project - you simply cannot expect to see results in a linear fashion but rather exponentially. Now translate what we just discussed into financial terms – project “auditing” refers to simply checking your statement and evaluating whether the investment is performing up to expectations.


The diagram below attempts to explain this vital point.

Point “A” is the commencement of the financial project. Unplanned audits (the black arrows) would have one disappointed as early as point “B” and more importantly lead to wrong and potentially disastrous conclusions.

A better strategy would be the one indicated by the block arrows. It takes into account the lead-time required for any project to get into “gear”, as it were, and the audit frequency is carefully selected to represent meaningful observation points. This will provide the client a much better view of what’s really happening with the project.

As an aside, there is a theory which states that once you’ve observed the state of anything you have, by definition, altered it. If you spend some time thinking about this statement and its practical implications you may find that you can spot at least one real-life example where this is the case. Food for thought!!

In conclusion, most of us have dealt with projects of varying degrees in our work and in our personal lives. Unfortunately, when it comes to financial planning we tend to place it in a category, more likely a vacuum, of its own. This inevitably can lead to trouble as it does not allow us to treat it in a fashion that we are familiar with and therefore invites misunderstandings and misinterpretations.

We hope that this short note helps to alleviate some of the potential problems and becomes a starting point for sound financial thinking and planning.

1 Just in case you have trouble coming up with an example, here is a bit of background and an explanation. It has long been scientifically established in quantum physics that the mere observation (which can be deemed as participation) of events at the sub-atomic level has consequences in the outcome of these particular events. By the same token, in our every-day life we alter the outcome of events by our own observations or participation even in a non-active form. An example would be our decision to take the bus when we observe a traffic jam from our window. This results in a change of the bus schedule, ever so slightly but in a very real way. Note also that our decision will also affect the traffic jam itself! Often times the alteration of events may happen subliminally i.e. we observe something which affects decisions that, at first glance, may share no common ground with the observation. As the paper says – food for thought!
What do you do when you have some money to invest?

At some point, we are all faced with the issue of what to do with our savings. It seems that, not so long ago, there used to be a simple answer to this question: go to the bank, purchase some government bonds or some other banking product, sit back and collect interest! Economies were localized, slow moving, almost unchanging. So were the interest rates.

Things are more complicated today. Inflation is low, but interest rates are even lower. There is a plethora of investment products out there but unfortunately they are not of the “buy-and-forget” variety. You need to be able to stay on top of your investments and be able to change things according to personal or market conditions – so you’d better have a good understanding of the investments you’ve made. Knowledge is key to success but not the only issue. You must be able to devote a reasonable amount of your time. Most of us do not have the luxury of looking after our investments as a full-time job.

At this point the thought of hiring a professional to manage your savings enters your mind - a wise choice. But where does one begin? There are as many investment managers out there as there are investment products! Everyone you know has a story to tell, some good some not so good. So what now? How do you pick the right company/person to do the job?

Well, for starters, you need to define the goal. The AMOUNT of money involved is the most important element. Why? Well, last time we checked, no one works for free. So in order to be worth having someone else look after your investments, there have to be enough funds available to allow for fees plus provide the sought after returns. So the amount available for investment will determine the type of “product” you’ll be looking for.

Think of it this way: if you were to purchase a car, the most important starting point is how much money you are willing to spend. There is no point in wasting your time at the Ferrari dealership if your budget says Yugo!

What has emerged recently is the trend to try and convince the potential investor that the price of entry into what were once products and services available to the rich has suddenly gone down! Look at the proliferation of Gold credit cards. Is there anyone out there without one? There was a time when these signaled a level of service apart from the crowd. This is no longer the case! The marketers at the issuing institutions have found out that by colouring a card Gold, you can collect a higher fee and provide the same service and credit facilities as before. It’s a moneymaker! Yet people “buy” it and pay the fee for the gold-coloured plastic.

Our point here is that the potential investor must not allow themselves to be misled into believing that they will receive something for nothing. This is a cardinal mistake that most people make. They are sold “private banking services”, or tremendous returns practically for no fees or risk! Seems too good to be true? Well, it is. So, evaluate your own situation carefully, and when you are talking to bankers or financial advisors keep this in mind.

The second important point is defining the DURATION of the investment. Unfortunately, that is an often overlooked point. Having money aside is fine, but if you are planning to purchase a house at the next available opportunity, or put the kids through college next year, then where you place it is of paramount importance! A good financial advisor should be asking these questions and preparing an investment strategy that allows for the requisite liquidity, if appropriate in your circumstances. Also make sure when you are looking at your cash requirement status, to allow for the time it takes for the actual money to appear as cash in your account i.e. there are investments that may require up to 3 months to be fully liquidated.

One other, overlooked point is that most peoples’ circumstances change. Your status at the beginning of the investment horizon and where you are today may have changed enough that it requires a total rebalancing of your portfolio. Do not wait until it’s too late to effect that rebalancing! A good financial advisor is one that is regularly in touch with you and thus able to make the appropriate changes in time to achieve the desired results, whether they are liquidity, security or something else.

The third important element is the level of RISK you are willing to tolerate. You may have heard the phrase “risk/reward” and this is absolutely key! You cannot make 20% a year on your investments with no risk, otherwise everyone would be wealthy and there would be no need for us to be writing this! So caveat emptor is a very appropriate phrase that every potential investor should keep in mind. A good financial advisor is NOT the one that promises huge returns but the one that seems fully grounded and explains the principles and risks involved.

So, to sum up, you can’t get something for nothing, be realistic as to your own needs and circumstances and make sure you understand that in order to make that huge return you must be willing to take a huge risk. We started by asking the question, “how do you pick the right financial advisor to do the job”. Well, if you follow the guidelines in this note and you speak to financial advisors, the answer will be obvious!

Happy investing!
Why do so many individual investors buy high and sell low?
Isn’t it ironic? The old axiom “Buy low, sell high” seems to have everyone confused! It seems simple enough; it’s only four words and it’s pretty straight forward. Then why do so many investors get it backwards?

If you can identify with this, and you are looking for the magic potion that will ooze out of these lines and make you do it right next time, stop reading now!

There is no simple answer. What we will attempt here is to explain why this happens so often and, having that in mind maybe just maybe, you can avoid the first part - Buy high.

Back to basic principles: What causes one to take the big decision, evaluate a security and decide that it’s at an attractive point to buy? The answer may be simpler than you think - Being a social animal. Most people believe that something is a good deal because they heard it on the news, overheard a chat at the local, or just plain talk between friends.

But in order for a company or security to be the topic of conversation, it must have done something spectacular PRIOR to that conversation, and usually it’s because its price has risen. So, continuing our line of reasoning, if it has reached levels that make it a social topic, then it’s probably already overvalued! So, you jump in with both feet only to discover that the price goes nowhere for a while (if you are lucky) and then slowly depreciates.

But of course at this stage, you are not willing to sell. If it was THAT high at some point, it’s going to go there again won’t it? So you wait while it does its snake dance, a little up and a little down (usually more down than up) and you sit there looking at your investment slowly turning sour. For every investor there is a point where they can’t take it any more and therefore, you sell to recover part of your money and fulfill the axiom in reverse.

Be honest! Does it remind you of someone you know? If the answer is yes then read on.

We, as financial advisors/portfolio managers find that most of our clients have experienced this more than once, some with severe consequences before joining our service. In fact, these are our “best” clients in the sense that they’ve suffered and know that managing a portfolio, minimizing risk and turning a profit is not an easy feat!

So, how do professional portfolio managers avoid being caught up in the rumour mill? Well, for starters, we don’t!

What happens is that portfolio managers have numerous sources of information and what distinguishes a good manager from a mediocre one is the ability to filter the volumes of information that arrive and decipher the nuances of the avalanche of data that lands in their offices.

Good portfolio managers have staff that continuously monitor the markets, and perform analysis from scratch. This enables them to arrive at conclusions that are not necessarily reflected in the market as it appears today but as it will be in the future.

Good portfolio managers set price targets and follow them religiously i.e. when a security reaches a certain target value it is sold irrespective of what the general market is doing at the moment. Discipline and adherence to guidelines is a key element of successful management. It sounds easy but in practice, it is quite difficult.

Good portfolio managers know how to properly diversify. The operative word is “properly”. Diversification does not mean buying a whole bunch of stuff but buying a whole bunch of uncorrelated stuff. This way, there is far less risk and less dependence on a given sector or equity.

Good portfolio managers know that they cannot get everything right, thus take the right steps to protect their clients’ portfolios from any possible downside. This knowledge is, at the end of the day, the saving grace.

Alas, buying high and selling low is a fact of life for the individual investor. It cannot be avoided. It will happen to you with the same certainty as death and taxes. If it hasn’t happened yet, take the right steps now so as to avoid it. If it has, then you are either already invested with a professional portfolio manager or you’ve withdrawn from the markets altogether.

Take the right steps now. Talk to your financial advisor and for a change, listen!




A POINT OF VIEW

Currencies are one of the most difficult and controversial aspects of portfolio management. In this paper, we will attempt to analyse the issues involved and try and determine an appropriate strategy for the investor that wants to minimise currency exchange-rate risks in a global portfolio.

The main issues are the following:

1. Investing in multiple, currency-diverse markets

2. Minimising exchange rate risks

3. Determining the appropriate strategy for each circumstance

To start our analysis, consider the following example: An American investor has $10,000 to invest. American interest rates are 3% and British interest rates are 5%. By keeping his money at home, the investor would receive $10,300 at contract maturity (one year). Alternatively he could take his money and convert it into sterling at the prevailing exchange rate, say $1.80 per pound. This would give him £5,555, which in one year’s time will pay £5,833 (at the 5% interest rate).
To eliminate any risk in the transaction, the investor would arrange to sell £5,833 at a fixed price a year from now. If the forward exchange rate is $1.77, the investor would have $10,300 in a year’s time, the same return that he would make on his dollar deposit. If the forward exchange rate were the same as the spot rate ($1.80) then the investor would receive $10,500 in a year’s time, and would have made more money without any risk. So competing investors will push down the forward exchange rate until it hits $1.77, the level at which the two investments end up equal.
The moral of the story is that markets have become very efficient and it’s becoming exceedingly difficult to make “arbitrage” money. So how do you invest in the global marketplace reaping real rewards and minimising exchange-rate risk?
You can’t. The moment you decide to swap some euros for dollars you are taking a risk. There has to be some careful evaluation as to why you are trading one currency for another; if it is because you believe that the target currency is undervalued then you are definitely delving into the realm of very sophisticated currency-modelling techniques that even the experts say are far from perfect. You are taking a gamble!

If you’ve swapped currencies in order to purchase an investment in the target currency then you must be aware that any and all profits may be quickly wiped out by an unfavourable exchange rate movement.
It is very clear that toying with exchange rates is not for the faint of heart. It takes some very serious evaluation and must take into account the personal circumstances of the individual investor. If one lives in Europe and consequently spends euros, what is of essence is that the final product of any given investment should be calculated in euros. There is no point in making a 10% profit in your U.S. stocks if the dollar is down 10% against the euro! You’ve taken risks and seen your rewards evaporated by the exchange rate. Even worse, if your investment is down 2%, then you’ve multiplied those losses six fold!
At WMS, we analyse each investors’ personal and financial situation very carefully and try to determine an appropriate strategy that can take advantage of the wealth of opportunities available in the world markets while always keeping in mind that the client has a “home” currency and ultimately, returns must be measured against that currency.
We evaluate investment opportunities with the exchange rate risk always in the forefront and only make purchases when we think that this particular risk is controlled. We have developed our own proprietary models that take into account a number of parameters which are very specific to the clients’ circumstances and appropriately determine the level of exchange-rate risk for a given portfolio.
To close, have a look at the graph below:

This real-life example demonstrates how currencies can make or break a global investment strategy. Tremendous care and skill are required to navigate these waters.
The graph depicts the Dow-Jones Industrial Average from January 2003 until June 2004.
The green line is the return in USD and the black line is the return in EUROS. As you can clearly see, the USD return is a healthy 24.59% and the return in EUROS is a measly (by comparison!) 6.85%. In other words, an American investor would have been elated with the returns and the brilliance of his/her strategy whereas a European investor MAKING THE SAME INVESTMENT would have been disappointed.
Case and point!