Currency risk takes centre stage

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If there is one thing many believe will result from this summer’s volatility in global markets it is that currencies have claimed a more important part of portfolio decision making.

However, there is other ­anecdotal evidence that investors are increasingly looking to diversify their currency exposure, such as in the Aberdeen Global Asian Local ­Currency Short Duration Bond fund.

Adam McCabe, the fund’s ­manager, says it is clear investors are shifting out of euros, sterling and even Swiss francs into Asia, with similar trends seen in the US.

Discerning investors are allocating capital away from currencies with the biggest challenges, says McCabe. But it also goes well beyond hedging currency risk.

These investors are looking for assets that are ­structurally more sound. They are looking for good ­balance sheets in companies.

But what they previously forgot and have rediscovered is that it is equally important for countries to have good balance sheets. This also explains why Asian c­urrencies have support.

These countries are structurally sound, with strong balance sheets, and are prudentially managed.

They have strong corporate cash ­balances and strong individual ­savings levels. And Asian currencies are cheap, McCabe adds. “Investors need to diversify at the right price. They are also acting as a safe haven in the current environment.”

McCabe also believes the euro will survive, although he warns about the impact of politics.

This does not just mean the response of European or US politicians to the problems undermining the euro or dollar, but that policy makers in Asia also have their objectives.

They are looking to harness the flow of ­foreign capital to help build domestic demand and infrastructure. Demand for commodities is ongoing, for example, from sources such as Australia.

But removed from the commodity context, investors can benefit from higher interest rates in countries such as Indonesia, where a policy of allowing currency appreciation coupled with a possible reclassification of the market out of non-investment grade make an appealing proposition.

Asian countries are increasingly looking to recycling surpluses into other Asian countries, partly as a response to the financial crisis of the late 1990s, McCabe says.

Governments and central banks entered swaps agreements that can be used for mutual support.

Then there is China’s estimated $3trn in foreign currency reserves.
On the broader issue of currency as an asset class, McCabe says people are becoming more aware of currency risk.

In equities, currency matters can be built into corporate analysis via, for example, which currency its ­earnings are exposed to.