Foreign index funds: An example

Continuing on from yesterdays post, I thought I would walk through an example of an investment I recently made in the FTSE100 index.

Rationale

The rationale for my investment was twofold

1. The UK market has been depressed for sometime now. This is the type of market I like to invest in as people are so scared of risk, if you are risk neutral (or less risk averse than most as I am) then this is the perfect type of market. I also tend to be a contrarian personality wise and am much more comfortable investing in the market when others are not (note this probably comes from losing half of my investments as I began my investing career just prior to the GFC)


2. The AUDGBP is at close to its highest rate ever in AUD terms. It is overvalued against almost every other currency. Now to be clear all I'm doing is making the bet that there will be some sort of reversion to a normal exchange rate. I'm not saying it will revert to the lowest levels nor am I saying that I am buying at the best price. However it is a price I am comfortable with where I think it offers significant downside protection against further declines in the FTSE100 index

You may notice that I have not included anything on fundamental valuations in the market above. For stock specific investments this is something that I would almost certainly do. However given that all you are left with is market risk when buying an index (and country risk in this case) you're essentially looking to see if you think the market is overblown. The UK market has shown marked declines since the GFC and being part of Europe is being tainted with Europe's woes so I'm comfortable that even if it is expensive on current earnings, once confidence returns to the area then share prices / the price of my index will recover.

Again I want to stress that in investing in index's my thesis is not around absolute valuations in the way my stock investments are. They are about a diversified "safe" investment for which I'm trying to get some downside protection which is what the currency offers me.

The Chart on the left shows the FTSE100 return over the last ~10 years in GBP (blue line) and AUD (pink line). The gap is purely exchange rate differences. The exchange rate risk is that that the gap widens (from a negative risk perspective) or that the gap wides (positive from a risk perspective).

While charts like this are highly dependent on your starting point, this particular chart tells the same story for almost all starting points (it is worth checking this prior to actually making your investment)

Execution

Once I decided that I wanted to make this particular investment I started to look around for an ETF that would give me the right exposure. I wanted full currency exposure so did not want any sort of currency hedge. The easiest way is to look for an ETF listed in your own country. This wasnt an option for me so I found the iShares FTSE100 index listed on the LSE (LSE:ISF). They are also listed on various other markets but I only wanted to the AUDGBP risk (i.e. I didnt want USD / EUR risk also mixed in).

I then used my Interactive Brokers account to buy my desired quantity. Since my investment the currency has moved against me slightly and the index has increased slightly so I am showing on a slight negative return. Ishares (run by BlackRock) has plenty of these type of investments which are definitely worth checking out.