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When Chasing Interest, Don’t Forget Currency Risk

For many years, interest rates have been extremely low in the UK and most other developed countries. If you are living abroad and your new country’s interest rates are much higher than back home, it is natural to think about ways to capitalise on the difference. The right strategy can significantly enhance your returns, but at the same time there are risks which many expats underestimate or completely ignore.
Do You Want to Earn 0.35% or 14.35%?
At present, central bank rates are at 0.5% in the UK and the US, 0.05% in the Eurozone, and negative in several other developed countries including Switzerland, Sweden and Japan. You can get a cheap mortgage, but you also earn close to nothing on your savings. At the same time, the rates are 6% in South Africa, 7.5% in Turkey, 11% in Russia and 14.25% in Brazil, just to name a few.
Why save at 1% or less in a British bank when you can earn multiples of that just by keeping the funds in a different currency? It makes complete sense, particularly when you are living there and big part of your expenses are denominated in that currency anyway.
Interest Rate Differences and Exchange Rate Changes
You have heard it before: There is no free lunch in the markets. To earn considerable returns, you must take considerable risks. In this case, the risk is that the currency you hold will depreciate and the resulting losses will wipe out or exceed any interest gains. This risk is very real. It happens all the time.
Even with the pound’s current weakness, in the last three years the South African rand has lost 38% against the pound, the Turkish lira has lost 34%, the Russian rouble 56% and the Brazilian real 46%. In spite of their high interest rates, you would have lost money on all of them.
According to an economic theory (named uncovered interest rate parity), when there is a difference in interest rates between two currencies, it is expected (other things being equal, which they never are) that the high interest currency will depreciate against the low interest currency, so the total return will be the same on both. For example, if interest rates are at 0.5% in the UK and 14.25% in Brazil, it is reasonable to expect that the BRL will lose approximately 13.75% against the pound in the next 12 months.
Theory and Reality
In reality, other factors come into play. Sometimes the high interest currency does not depreciate that much and you indeed make money holding it. However, other times it loses much more than “expected”, as seen on the examples above.
The risk of disproportionate adverse moves in emerging currencies is particularly high at times of global liquidity shortage and increased risk aversion, such as in the 2008 financial crisis or the 1997 Asian currency crisis, which spilled over and contributed to subsequent problems in Russia, Brazil and Argentina. The problem with these events is that you never see them coming until it’s too late. Furthermore, even an otherwise stable country’s currency can often be affected only due to market sentiment and its emerging status.
What It Means for Your Finances
The above does not mean you should always keep all your savings in GBP or other major currencies. It means that whenever the currency structure of your income, expenses, assets and liabilities is in mismatch, you are exposed to currency risk. For instance, if you are living in Brazil and saving in BRL, but planning to eventually return to the UK or retire elsewhere, you are to a large extent betting your future on the BRL exchange rate.
Make sure you know what you would do in an adverse scenario, such as a currency crisis, however unlikely that might seem at the moment. Keep at least a portion of your savings in a strong and stable currency, even when the returns don’t look that attractive. It is widely known that rich families in places like China or Russia prefer to keep big parts of their wealth in developed countries, giving up the higher returns they would earn at home. They do it for a reason and that reason is safety and stability.
You can allocate some funds to high-yield currencies and riskier investments, but with the core of your assets, like the pension pot, it should be defence first. Don’t bet your future lifestyle.

MESSAGE FOR UK NATIONALS LIVING OVERSEAS ON HOW TO REGISTER TO VOTE IN THE UK ELECTION

This week the UK Electoral Commission has launched a dedicated overseas voter registration campaign. The campaign aims to encourage British citizens living overseas to register to vote ahead of the UK Parliamentary General Election, due to take place on Thursday 7 May 2015.

To mark the start of the campaign, the elections watchdog is hosting Overseas Voter Registration Day on Thursday 5 February 2015 in a bid to boost the numbers of UK residents overseas on the UK’s electoral registers.

This is the first UK General Election where people can register to vote online. The Electoral Commission hopes that the new online process will encourage more UK nationals living overseas to register to take part in elections from overseas.

Estimates show that there may be as many as 5.5 million UK nationals living overseas, but there are fewer than 20,000 currently on the electoral registers.

To register as an overseas voter, UK residents overseas must have previously been registered in a UK constituency within the last fifteen years.

To register to vote, UK citizens should visit https://www.gov.uk/register-to-vote

Overseas voters can choose how they want to vote. They can vote either by post, by proxy or even in person (if they will be in their constituency on polling day). The deadline to register to vote is midnight (BST) on Monday 20 April 2015. The deadline for applications for postal votes is 5pm (BST) on Tuesday 21 April 2015. The deadline for applications for proxy votes is 5pm (BST) on Tuesday 28 April 2015. Overseas voters should apply as far in advance of this as possible.

Pensions Institute: ‘Almost all’ active managers fail to beat the market

Pensions Institute: ‘Almost all’ active managers fail to beat the market

This article confirms something that those of us involved in looking after client money have known for quite a while, namely that most active fund managers, despite charging extra for the pleasure, are incapable of beating the markets. This underpins our evidence based investment philosophy. To cut a long story short, the evidence from years of academic research, in many cases by Nobel Laureates, firmly suggests that the factor which has the greatest eventual impact on the returns (strictly variability and therefore expected returns, to those of you who are investment boffins) of a portfolio is the high level asset allocation, i.e. the split between equities and bonds. Strategies such as market timing (when should I buy or sell or should I hang on a little longer for the turn?) and stock selection (should I buy Tescos or M&S?) have been shown to have very little impact. Since these are the main methods supposedly used by active fund managers to add value, it comes as no real surprise that most of them fail. I say ‘supposedly’ because many simply track the markets and charge extra for doing so!

So, if you are looking for a portfolio that collects as much as possible of the market rate of return, according to the level or risk that you wish to take, start with the high level split. Then choose low cost funds and perhaps tilt towards sectors that have demonstrated an ability to provide extra returns given a certain amount of extra risk. Above all, avoid succumbing to the perfidious temptations of the financial porn which is regularly pushed out by the active fund management industry. They are thinking about themselves, not you.

BEWARE OF PENSION PREDATORS

Following the recent UK Budget, major changes have been announced for pensions. From next April, it will no longer be necessary to draw an income. Instead the whole fund can be cashed-in. The first 25% will be tax free to UK residents (but not necessarily to residents of other countries) and the balance will be subject to tax at the pensioner’s marginal rate. So far so good. At the same time, the Chancellor has announced, since this might encourage a lot more people to take their pension funds as a lump sum and, since government pensions are unfunded (that is to say they are paid out of annual tax revenue as they arise), he would be enabling such pension schemes to no longer offer transfer values.

This leads me to the reason for the title to this article, as clients of ours have already been approached by ‘advisers’ recommending that they get on and transfer their pension to a QROPS before the opportunity to do so runs out. The question is, just because you might not be able to do something in future, does that mean you should do it now?

On our travels, we see all sorts of extremely poor advice regarding pensions, amongst other things. All manner of completely spurious reasons are given for transferring. These include, that the UK pension is ‘frozen’, it will be subject to UK tax, it might all be lost if the employer goes bust, to name but a few.

Lets start with what you are giving up by transferring out of a UK defined benefit scheme, such as the Teachers Pension Scheme or any major employer’s scheme. Under long standing UK legislation, such benefits are effectively inflation proofed both before and after payment. They are guaranteed by the government in the case of public sector schemes. For private sector schemes, in the first instance, they are backed by the financial strength of a major corporation but even if they go bust, there is the mandatory Pension Protection Fund (to which all UK pension schemes must subscribe) , which provides protection for 90% of the benefits for most people. It is therefore completely untrue that UK pensions are ‘frozen’ once you leave or that they are at risk of being completely lost if your ex-employer goes bust. There is there no justification to transfer out on the grounds that the benefits will be static or somehow at risk.

Furthermore, UK pensions can be paid anywhere in the world and due to the large number of double taxation treaties between the UK and other countries, in many instances, the income can be paid free of UK tax. Even if it is subject to UK tax, British citizens still have their personal allowance of over £10,000 per year, which covers most people’s pensions. So, there is no justification for transferring in order to improve the tax treatment.

Of course, there are circumstances when a transfer may be worth considering. These include: funds in excess of the lifetime allowance, the need to secure benefits on a different basis to the original scheme or sometimes improve death benefits, or to use the fund for specific purposes perhaps by a business owner wanting to use it to acquire trading premises.

Occupational Pension Transfer advice is a very specialist area. It requires a balancing of the benefits to be secured with those which will be lost and a determination as to whether the proposed transfer is worth it, or not. This involves the carrying out of a transfer value analysis calculation which determines the rate of return (the critical yield) needed by a private scheme to match the benefits being given up. It also analyses and compares things like tax free cash entitlement and death benefits in the existing and proposed schemes. You would usually expect to receive a pretty comprehensive suitability letter either recommending that you transfer or, actually more likely, that you do not. Prior to receiving the advice, you should expect to be asked lots of questions about your requirements and preferences and most likely be required to complete a range of questionnaires on your investment risk and on your specific attitudes to your pension arrangements. UK advisers are required to presume that the default, most appropriate course of action is for pension benefits NOT to be transferred and therefore when giving advice, the case for transferring must be made, not the other way round.

In the UK, advice on occupational pension transfers may only be provided by financial advisers with specialist qualifications. It is actually a regulatory offence, liable to result in a fine, striking off and possibly even a criminal conviction for a non-regulated adviser in the UK to provide advice in this area. Such restrictions do not apply to people operating in this market from outside the UK. Here is a summary of the FCA’s requirements.

Which leads me to my conclusion. If you have been been approached by an adviser based out of an office in Eastern Europe, Spain, Malaysia, Thailand or, anywhere other than the UK, suggesting that you should transfer your UK pension to a QROPS – think twice. You might want to ask them what specific pensions qualifications they hold. Ensure that you obtain a proper report from them covering all of the points above. If they don’t burden you with lots of questions and send you a lengthy and probably tedious report with lots of numbers crunched, ask yourself why. How can they possibly know that the transfer is good for you and having perhaps determined that it is, how without a proper report, can they be sure that you are making a properly informed decision? Better still, seek advice in the UK from a properly qualified and regulated adviser. As an expatriate, you may not benefit fully from UK regulation but the adviser is obliged to conduct himself in a fit and proper way and to provide advice to the required standard, no matter where they are based.

This is only a brief summary of the issues. The UK regulator is so concerned about the shenanigans that have been going on and the predatory activity, particular from offshore, I hesitate to call them ‘advisers,’ that it has issued a fact-sheet, which you can access here.

Our associated UK regulated independent advisory firm provides qualified specialist pension transfer analysis service to UK clients and expatriates. It also assists other advisory firms who don’t hold the required qualifications or regulatory permission to provide such advice to their clients. If you have a UK pension are concerned about whether it is suitable for your needs, or have been approached by someone suggesting that you transfer it, they would be happy to help. For further details please contact Phill or myself.

Christopher Wicks ACII FPFS CFP
Chartered Financial Planner

Retirement Planning for Expatriates

Retirement Planning, in common with all financial planning is just a funding exercise. It deals with a fundamental fact of life that confronts all of us, namely that at some stage, whether you like it or not, you are going to have to stop working. When that happens your earnings will cease and you therefore need to build up a replacement income sufficient to maintain the standard of living to which you have (or would like to) become accustomed. It does not matter where the replacement income comes from but it needs to come from somewhere. One thing is for sure, it is not going to magically appear, so a plan is necessary.

The starting point is to work out how much you need to live off in retirement. This can be difficult because your circumstances can have changed quite a bit. That said begin by looking at your current expenditure. Apart from totting up all of your payments you should take note of what you are spending your money on. Some items should have stopped by the time you retire, at least in theory, such as mortgage and children’s education costs. However if you are on an expat contract and your rent is paid, you are going to need to start to pay full housing costs. So you add things on that you will need to spend and deduct items that will have stopped. Incidentally, when you carry out this analysis, look at what you are spending on utilities, insurance, and bank interest. If you shop around now, can you save some money?

Once you have worked out how much you need, the next thing is to calculate the level of income that you already expect. If you are entitled to the UK state pension you can obtain a forecast. The same should go for state pensions from other countries. You can also obtain projections for private pensions from the UK and other territories. You should also take into account the value of existing savings and investments as well as any rental income if you have investment properties. Do not include rent from the home you intend to return to, since this will stop when you move back into it. You may need to run some projections based on your current rate of saving and the present value of your investments and pension funds. Bear in mind that these need to take the effect of inflation into account.

Having determined what you need and how much is coming in, the final step is to work out the difference. This is what you need to fund. If you are going to build this up using regular savings, you need to convert it to a capital sum. In order to ensure that your target income is realistic, you should assume a similar rate to an index linked annuity in the UK and back calculate from there. You then need to calculate the regular monthly amounts that you need to save in order to arrive at the amount of capital needed to provide your target income. Simple!

Of course, all of the above is complicated by the fact that you are expatriates. You may not return to your country of origin. You need to consider the likely rate of inflation where you plan to retire and also the effect currency fluctuation on your savings. You also need to decide in which currency you wish to make the savings. Taxation is also an important consideration and you will need to plan for this well before you implement any transactions.

If this sounds daunting, it need not be. It is all in a day’s work for any competent financial planner with experience of dealing with expatriate personal finances. In addition to helping you with the basic funding calculations they will also be able to advise you on the best way to build up the necessary retirement income and hopefully help you to adopt a sound evidence based investment strategy, which gives you the best chance of achieving your goal for the level of risk that you wish to take. 

Bridgewater’s new website is here!

Bridgewater’s new website is here!

We are pleased to re-launch our website which contains information about the services offered by Bridgewater Financial Services Limited, Independent Financial Advisers based in Sale Cheshire, serving clients in the UK and worldwide.