How often can a perfectly balanced and well diversified portfolio suddenly find itself ruined by the machinations of the foreign exchange market?
Traditionally many advising on investment would have focused on the right funds, stocks and bonds, with key measures of volatility and correlation all being carefully watched and controlled.
However, one vital area where few seem to have much management or control seems to have the ability to wreck everything when it was all going so well. In the UK, whether you regard it as a benefit or a hindrance, we have to live with the sometimes irrational behaviours of what can at times be a very volatile asset class – our currency – sterling.
The days when we could rely upon the pound as a major reserve currency are long gone. About 4 per cent of global reserves are in sterling, as opposed to 24 per cent in euros. And of course the US dominates with 64 per cent in dollars. One day that may change, especially if the Chinese have anything to do with it, but in the meantime the pound will react to the value and demands of the others and have far less influence either over the others or, come to that, itself.
The pound is becoming a storm-tossed cork in a sea of currency liquidity – other people’s currency liquidity.
Thus as money managers, currency management is as important as fund or portfolio management. This does not necessarily mean that we have to be seen to be prepared to be taking bets on currency movements (many of us over the years will have experienced that pain and fear), but rather the management and mitigation of the risks of currency movements.
The current populist headlines of ‘currency wars’ have drawn it to the attention of clients who otherwise would probably not have been so aware of such issues.
Certainly it seems the charms of sterling being fêted as a safe haven are beginning to wear off as economic concerns and worries over our credit rating come to the fore again. The euro, despite the current shorter term growth figures, will still likely see strength, if only as being a sobriquet for the old Deutschmark.
Then take the US growth figures and their unending optimism; this too will see further purpose behind the strength of the dollar. In fact it may only be the Japanese yen where devaluation by design and policy may flatter sterling to deceive.
Hedging policies for portfolios are thus going to be a vital part of portfolio management, even if the decision is to do nothing – i.e. leave unhedged – which is as much a policy as an active hedge. Maybe then the US dollar and the euro deserve to be left open as their denominated investments rise against the pound, with the yen being suitably covered.
Well that may be the current practical view, but be prepared to change. If circumstances change then so may your policies – but no policy is not acceptable.
