With dollar weakening, how should investors juggle their portfolio mix?

The first-half of 2025 saw the worst performance of the US dollar (USD) in over 50 years.

This comes on the back of an extended, multi-year period of USD strength. By its peak in January this year, the US dollar had risen almost 50% in inflation-adjusted terms against a trade-weighted basket of currencies of major US trade partners from the low in July 2011.

The outlook for a structurally weaker USD in the coming years means that investors are likely to have to unlearn the lessons of the past 15 years and plan accordingly.

Before we discuss the implications of USD weakness, let’s examine its drivers. The starting point is its overvaluation. According to the Bank for International Settlement’s measure, even after the sell-off so far this year, the USD real effective exchange is trading around the previous peak level of February 2002.

The second driver is the USD’s reserve currency status. For decades, the USD has been seen as the world’s pre-eminent reserve currency because of the US’ deep capital markets, strong regulatory infrastructure and predictable policymaking institutions.

The latter two factors have clearly been eroded quite significantly over the past six months. This is not to say the USD’s reserve currency status is really under threat – there is no clear competitor – but its advantage is slowly being chipped away.

The third driver is the US’s balance of payments position. The US’s net international investment position has deteriorated sharply in recent years. Here, former President Biden’s fiscal stimulus following the COVID pandemic played a significant role by creating excess domestic demand, resulting in a wider current account deficit.

This means the US has to attract huge amounts of capital inflows from abroad just to stop the USD from weakening.

Against this backdrop, what would a weaker USD mean for investors?

There are three angles to look at here: portfolio construction, managing FX risk practically and the emotional aspect of the impact of FX movements on returns.

The first question is the easiest to answer. We can summarise the impact of a weaker USD as:

Therefore, the first defence against USD weakness is to be invested, especially in equities and gold. A weaker USD also argues for reducing exposure to US equities, and indeed we have trimmed our US equity allocation in our globally diversified portfolio.

The arguments in favour of this approach are high valuations, the extremely high weight of US stocks as a percentage of global market capitalisation and the uncertain impact of US import tariffs on corporate profitability.

After all, the tariffs will be ‘paid for’ by an uncertain mix of i) exporters who will have to reduce prices, ii) US producers who will have to absorb some of the tariffs, thus hurting profit margins, and iii) consumer who will have to pay increased prices.

However, the US is still the world’s biggest equity market and the source of a lot of innovation. Meanwhile, US equities generally do better in a weak USD environment than in a strong USD environment.

Therefore, we retain a significant allocation to US equities in our portfolios. What it does mean is that we have increased our allocation to non-US equities, primarily via an increased allocation to Asia ex-Japan equities.

The second question is whether to hedge the USD currency exposure emanating from your portfolio. For equities, we generally do not think this makes sense as a lower USD should boost US corporate earnings as overseas profits get translated into a weaker currency.

For USD bonds and USD-denominated deposits, it is more difficult to answer. Naturally, the potential returns for bonds are generally lower than for equities and therefore currency fluctuations can really make a big difference to returns in your own currency.

However, you also need to factor in the hedging cost, which can be significant. Therefore, hedging USD bond exposure is certainly something to consider. However, you should approach it in a measured fashion, perhaps taking advantage of short-term bouts of USD strength to increase hedge ratios.

An obvious aside is that it makes sense for any deposits to be diversified across different currencies and not just in USDs.

The final part of managing currency fluctuations is how to manage your emotions. I think we all understand that a diversified foundation portfolio, which includes overseas investments, is important and that this comes with currency risks.

There will be times when the portfolio is doing well in one currency, but not in another, especially over shorter periods of time.

The way I manage this is to look at my portfolio over time in terms of different currencies, such as the USD, GBP and SGD. This gives several perspectives of the performance of the portfolio.

Of course, if there is an equity bear market, then all three versions of the portfolio are likely to be lower in value, but it does give some sense as to how much of the movement is down to pure FX movements.

This may keep you from over-reacting to portfolio fluctuations measured in one currency, but also highlight where you might have an excessive currency exposure that you should be managing over the longer term.

As with all aspects of investing, these decisions are very personal. The key is to try to decipher short-term fluctuations and long-term trends. A weaker USD environment is something we have not been used to for a long time and will have significant implications for different asset classes.

However, tweaks to your investment style are in order – by slightly reducing your exposure to USD-based assets – rather than a massive overhaul.