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.

In the bond market, currency risk can be separated out more naturally. He points to the development of emerging market (EM) debt products and local currency denominated bond funds.

The recycling element is important, because while traditionally Asian investors sought liquidity through European and US markets, they are now moving more aggressively towards emerging markets.

Shift in power

McCabe says he has seen a big increase in interest in local currency bonds from “old money” centres in the US and Europe.

Philip Poole, Global head of macro and investment strategy at HSBC Global Asset Management, believes currency volatility is here to stay.

Investors are being tempted into viewing currency as an effective asset because of the pressure on yield from fixed income instruments. Interest in currency will be higher in a low interest rate environment.

But investors looking at currency in the context of emerging markets should not necessarily be thinking in hedging terms, he adds. Instead, it may be advantageous to have exposure to EM ­currency risk over time.

Poole also does not believe the euro will crash, but says there is a chance the constituents of the eurozone could change over the next half decade as a result of the crisis.

He agrees it is as much a ­political problem as anything else, considering there is currently no fiscal union and the ­so-called Maastricht rules, the criteria ­governing adoption of the euro, “lack teeth”.

One advantage the euro does have is that countries such as China are still intent on diversifying their foreign currency reserves away from the dollar (see box, above).

China and India could diversify into an asset such as gold. But in ­currency terms, the sheer volume of surpluses being generated means there are few options to the dollar other than the euro. Currency as an asset can offer the liquidity, but not all currencies can do so equally.

Asian currencies are attractive because they may be cheap and offer a good running yield, Poole adds.

For example, on a PPP ­(purchasing power parity) basis, the ­currencies of China, India, Mexico and Turkey ­looked undervalued over the summer, offering interest rate ­differentials against one’s own ­currency.

Hardeep Dogra, portfolio ­manager at Schroders, says that PPP is a ­prominent objective of the Schroder ISF Global Managed Currency Fund, where he works to preserve purchasing power through exposure to a basket of currencies.

The idea is to diversify through currency, but not take bond or equity risks. The Greek crisis played its part in concentrating minds of investors on risks in the market, and created awareness of currency as affecting returns, Dogra says.