What part does currency play?

Should currency value play a part in investment strategies? Some consider them to be a secondary factor, while others are choosing to avoid currencies with a varying performance

Gains from currency swings are a welcome bonus but playing foreign exchange movements is usually not part of
their overall investment strategy, Adviser Fund Index (AFI) panellists say.

“The majority of [recent] global returns were because of currency movements and not because of the funds’ performance,” says Hilary Coghill, the chief investment officer at City Asset Management. “Japanese funds, for example, were up last month because the yen has performed so well against sterling.”

Ben Willis, the head of research at Whitechurch Securities and a fellow panellist, agrees. He says currency swings have especially helped his Japanese funds. “By the end of last year and in the beginning of this year, we had some incredible returns. The performance of the funds was ok. But the out-performance was attributable to currency effects.”

“The biggest beneficiaries from currency swings were funds held in the yen and the dollar,” says Mick Gilligan, the head of research at Killik. Currency swings have benefited funds he holds: Findlay Park American Smaller Companies, Neptune Japan Opportunities and First State Asia Pacific Leaders.

Brian Dennehy, the managing director at Dennehy Weller, agrees with his fellow panellists. “Jupiter’s Japan fund, for example, has had a 40% dividend increase,” he says. He says that currency swings for all overseas funds have had a big influence on funds over the past couple of months.
While the panellists share the same opinion on the yen, their opinions on sterling clash.

He says over the past couple of months, sterling has been the worst performing currency in his portfolio. And Gilligan expects sterling to weaken further against the dollar because of the “indebted British economy, the government’s weak finance, weak consumption and a banking system that has not been resolved.”

As for managing risks, Dennehy says he tends to buy unhedged funds because “over time, the sterling tends to be a weak currency”. He says: “People expecting the sterling to become strong have to be extraordinary optimists.”

Coghill is an optimist. “We think that sterling is undervalued against the euro.” She expects the British currency to appreciate.

“We’ve been looking at funds in the global bond sector where fund managers actively manage currency risks.” For example, she is currently monitoring Neptune’s newly soft-launched bond fund. And its fund manager is a currency expert. “I have started investing in it and may include it in the next review,” Coghill says. “But we have to be careful. It’s not easy money.”

She points to the fall in sterling since the summer of 2008. “It used to be worth more than $2 but now it is only $1.37. Those that had investments in euro and dollar gained. But we don’t expect that to happen again,” Coghill says.

Gilligan is more wary of the British market. “In terms of UK equity, we’ve been focussing on funds that have greater exposure to non-UK equity because of the translation effect and the diversity of earnings,” Gilligan says. However, he adds that he focuses on sectors rather than currencies. “The currency is only a secondary consideration.”

Davies, also says that he does “not really take currency swings into consideration when we make investment decisions.” He says: “We try to avoid currency risks as much as possible because currency [performance] is something beyond what we can predict.”

He says: “As most asset classes are going down, people are looking for other ways to make money. It is always tempting to jump ship and go into currency speculation.” However, Davies adds, that he focuses on long-term strategic asset allocation.

Davies says “there are lots of different ways to make money but our risk-benefit analysis says that currency speculation is not something we want.”

Willis, his fellow panellist, agrees. “Currency swings are secondary,” he says. “We generally focus on a sector, a region or a theme. When we are bullish on a certain sector or a certain region, we invest there regardless of the currency.” He says that he sometimes does actively consider currency effects. “For example, at the moment we are not very keen on Europe. And part of the reason is because of the strong euro.”

Dennehy says: “Currency gains are a bonus and if we get them it’s marvellous”. However, he says that he would not invest in a certain region because its currency looks promising. However, he tries to avoid places where there was “an obvious currency risk”.

“We are still not keen on US markets although US stocks look like fair value,” he says. “People tend to believe that the US is going to come out of the recession first. But the risk that the dollar will become weaker is real.”

He says investors that want to benefit from America’s stabilisation, should better turn to Asia because it will be the first region to benefit from America’s stabilisation.

Monthly exchange rate for sterling

The Adviser Fund Index series – a summary
The Adviser Fund Index series comprises an Aggressive, Balanced and Cautious index each tracking the performance of portfolio recommendations from a panel of 18 investment advisers. For each risk profile, all panellists specify a weighted portfolio of up to 10 funds from the authorised UK unit trust and Oeic universe that, when aggregated, define the constituents and weightings of the three AFIs.