Currency managers see investment opportunity where others see a currency war.
Central banks' efforts to boost their domestic economies have caused volatility in global currency markets that managers say is buoying the firms' growth prospects following the difficult cycle that began with the financial crisis.
Generating consistent, positive returns has been a challenge for currency managers in the past five years, with most failing to make up for the sharp downdrafts they suffered in 2008, said Nigel Rayment, executive director with J.P. Morgan Asset Management (JPM) in London and a senior client portfolio manager in the global fixed-income, currency and commodities group.
But with the recent emergence of market-driven themes that managers have been able to take advantage of — such as yen weakness — performance has been improving of late, Mr. Rayment noted.
Against that backdrop, currency managers are reporting a pickup in talks during the past six months with institutional investors.
Growing overseas allocations and mounting concerns about the inevitable “great unwind” of the aggressive, unconventional monetary stimulus by developed-country central banks are leading to more discussions with sophisticated investors, said Kevin Anderson, global chief investment officer of fixed income and currency with State Street Global Advisors in London.
While business hasn't surged on recent currency war speculation, SSgA is enjoying “a continued healthy increase in the number of mandates we're managing” for hedging and overlay and to deliver alpha, Mr. Anderson added.
James Wood-Collins, CEO of Record Currency Management, London, said his firm has seen “a marked increase in in-bound inquiries” since late in 2012, mostly for hedging but with some interest in alpha-seeking strategies as well.
Following a difficult stretch during the past four years, Record's client roster shows signs of stabilizing. Record reported 43 clients as of Sept. 30, 2012, a gain of two in six months but less than one-third of its peak of 141 in 2008.
But recent developments suggest the business environment for currency management remains challenging. In July, for example, Aviva Asset Management closed its currency business, citing lack of client demand. In September, BNY Mellon Asset Management announced it would merge its Pareto Investment Management currency boutique into liability-driven investment affiliate Insight Investment Management (Global) Ltd., both of London.
Currency managers agree there's been no spike in hedging mandates as a result of growing talk that the U.S., Europe and Japan could end up pursuing competitive devaluations of their currencies to gain an advantage in stimulating their economies.
In a Feb. 6 report, Manoj Pradhan, London-based analyst with Morgan Stanley (MS), called the aggressive policy stance adopted by a newly elected Japanese government at the end of December a “game-changer” that could bring the world a step closer to a currency war.
On Feb. 8, Venezuela devalued its bolivar by 32% against the U.S. dollar. And on Feb. 12, the Group of Seven developed economies, amid growing fears of a “beggar-thy-neighbor” catfight, felt compelled to issue a statement pledging members' commitment to market-determined exchange rates.
According to Michael DuCharme, senior currency strategist with Russell Investments, Seattle, the ultra-loose monetary policy being pursued now by central banks in the U.S., eurozone and Japan has investors with the largest non-domestic allocations — led by Europe — more concerned about their currency exposures, with a resulting pickup in currency-related RFPs. But no one seems to be losing sleep about a currency war, he said.
For the most part, currency managers agree that recent currency war rhetoric has been overblown.
The Japanese government has managed to lower the value of the yen by 15% or so simply by suggesting it will stimulate the economy, and no country has even hinted at the kinds of protectionist measures that would warrant a more apocalyptic frame of mind, noted Thomas Kressin, a Munich-based manager of global bond and foreign exchange strategies with Pacific Investment Management Co.
Japan hasn't done anything that could be interpreted as firing the first shot in a currency war, agreed SSgA's Mr. Anderson. Stimulating domestic growth remains the order of the day, with no signs of moves that would force other countries to respond, such as trying to inflate away the national debt, he said.
Currency managers say a currency war hasn't been a major topic of conversation with clients or potential clients.
One pension executive for a corporate defined benefit plan with more than $5 billion in assets, who declined to be named, said one argument against currency hedging is the fact that a country that competitively devalues often enjoys equity market gains that more than offset any devaluation.
That has been the case with Japan. From mid-November, the yen's value has fallen by roughly 19% — and the country's Nikkei 225 stock index has surged 30%.
An additional factor, noted the pension executive, is the difficulty of figuring out the currency exposures of the listed multinational corporations that dominate equity allocations. For example, he said, a European investor who hedged 100% of his investments in IBM Corp. or The Coca-Cola Co. out of concern the dollar could weaken would be massively overhedging companies that get 60% of their revenues outside the U.S.
Still, the executive said the outlook now for currency volatility makes it an opportune time for tapping a skilled manager to run an unfunded foreign exchange overlay, although he said the scale of the market opportunity probably argues in favor of a modest target of 200 basis points of absolute returns.
Paul Lambert, a portfolio manager and head of currency with Insight, London, said the recent pickup in volatility, after years where major currencies kept to fairly narrow ranges, could prove a much more favorable environment for alpha-seeking currency managers.
In an e-mail, Philip Simotas, president of New York-based FX Concepts LLC, agreed. Current prospects for delivering strong returns are “the best I have seen in years, with lots of opportunities,” he said.
The fundamental arguments for optimism include Japan's decision to drive real interest rates down, in part through a weaker yen, which will effectively restart the debate “about hedging FX for equity and bond returns,” Mr. Simotas said. The return of inflation, which will leave governments more inclined to let their currencies rise to stabilize prices, is another support, he said.
Another driver, Mr. Simotas said, is that “we are increasingly in a world of regions,” with the U.S., European Union and Japan all focused on domestic policy. That makes for more divergent trends between emerging and developed markets in foreign exchange, he said.
If currency managers are better positioned to deliver strong returns, a continued weakening of home country bias will force investors to revisit the question of how to manage ever-more-complex currency exposures, market veterans say.
"Most confusing thing'
Currency is the “most confusing thing in the investment world, bar none,” noted Ronald G. Layard-Liesching, chairman of currency manager Mountain Pacific Group LLC, Bellevue, Wash. Still, currency is more important for returns than ever, with institutional investors going global even as unprecedented quantitative easing and the rise of new investors creates a new and unstable market dynamic, he said
The continued growth in overseas investments leaves more investors sitting on global equity weightings with exposures of 50% in the U.S. dollar, 30% in the euro and 8% in the yen — “a terrible and undiversified currency basket,” he said. For them, choosing a benchmark that provides a more sensible diversification is key, said Mr. Liesching.
The FTSE Wealth Preservation Unit that Mountain Pacific developed in tandem with FTSE has been one attempt to offer that better diversification, with a basket of currencies that includes roughly 23% exposure to the U.S. dollar; a combined 18% among the Canadian dollar, Australian dollar and Swiss franc; a 14% weighting to developing market currencies; and a 4% allocation to gold and oil. n
This article originally appeared in the February 18, 2013 print issue as, "Currency managers welcoming volatility Money-supply programs create growth opportunities".