In addition to markets becoming calmer, the performance of the G10 economies is starting to differentiate. Most notably, the US economy is beginning to show signs of a recovery.
Malcolm Leigh, investment principal and specialist in currency at Mercer, says: “This re-emergence of some differential performance between different countries is bringing back currency volatility which allows active managers to start making money.”
Owens concurs: “Currency movements are once again reflecting the difference in economic fortunes. The three worst performers so far this year are the rand, the yen and sterling. Each economy faces huge issues. In contrast, the best performing currency is the Mexican peso and its economy is looking very favourable.”
The re-emergence of currency volatility creates both problems and opportunities for institutional investors. The sharp currency moves seen in recent months can create significant short-term problems.
Johanna Kyrklund, head of multi-asset investment at Schroders, says: “If currency risk is not properly managed it is like an iceberg in the portfolio. People have underestimated the impact of currency, partly because there is a view that equities are a natural hedge. But I think that’s wrong: currency risk needs to be properly analysed and managed.”
It might well be the case that for a global portfolio, the currency movements of different geographic regions will cancel each other out.
Kyrklund says: “But investors need to carry out the necessary analysis to establish that is the case before concluding that they can leave the portfolio un-hedged. I’m of the view that no risk in a portfolio should be ignored and currency is an important risk to understand.”
An active attack
Currency is not only a risk factor for portfolios; it can also be used to add value for a portfolio as an actively managed asset class in its own right. Many institutional investors may unwittingly already be using currency to add value to their portfolios.
Jeppe Ladekarl, director, global macro at First Quadrant, says: “Many institutional investors might not realise that currency is being used to actively add value to their global fixed income allocations.”
Many fixed income managers make returns above an international fixed income benchmark by making active currency decisions.
“The manager is given some leeway to their investment decisions in order to add value to that benchmark. They can aim to beat the benchmark by taking a view on credit risk, duration and the interest rate curve as well as long/short bets on currencies,” says Ladekarl. The greater the return target, typically the greater allocation to currencies, he adds.
While many institutional investors have been wary in the past of using currency as an active asset class, now that a degree of normality has returned to the FX markets, it is worth revisiting this idea. Currency has the advantage of lack of correlation with equity markets.
Owens says: “It’s very hard for institutional investors to find an asset class that will provide growth other than equities, now that fixed income generally offers a low yield. Investors frequently ask me: ‘Other than equities, where do I put my money?’”
There are various options available to institutional investors. Active currency managers can be employed to make active returns out of currency. But investors need to find those managers who have adapted their strategies to reflect the current market conditions.
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