When a fund manager invests overseas they take on currency risk, which has to be managed. Multi-managers deal with the risk in a different ways, says Anthony Rayner, fund manager, Premier Miton Investors
One of the advantages of global multi-asset funds is that they have a large number of investment opportunities. Additionally, the sub-asset classes often behave in meaningfully different ways, providing several levers to pull. A large and varied universe of opportunities suits our approach to investing, as we look to construct a diversified selection of macro and thematic ideas for our portfolios.
The opportunity to diversify within multi-asset portfolios is well known but a related dimension of multi-asset funds that is often overlooked is currencies, which is often seen as an asset class in its own right.
As soon as a fund manager invests overseas, they take on currency risk, though they can of course hedge that currency back into sterling and therefore eliminate that risk and just retain exposure to the underlying asset. Arguably though, investors are also taking on risk by keeping all their assets in sterling, rather than diversifying some currency risk.
Multi-asset fund managers have very different ways of dealing with currency risk, some pay little attention to it, some hedge virtually all their overseas currency exposure back into sterling and others lie somewhere in between. For our part, we are risk orientated when it comes to currencies.
An important part of our overall philosophy is to be as pragmatic and open-minded as possible, rather than benchmark constrained. This means we can often bypass risks that we think are too opaque. Take UK assets, we don’t have to own UK equity or gilts, or UK REITs. In fact, we are acutely aware of falling into the trap of ‘home bias’, a global phenomenon where investors prefer their home market, as familiarity tends to breed false confidence. In practice, our exposure to these three UK assets has varied materially over time, including being close to zero.
However, we do have to have a position in sterling, one way or the other, otherwise currency risk would end up being the dominant risk in portfolios. Our general view on currencies is that they are difficult to value, have a relatively high volatility profile and should be viewed in a risk, rather than return context. As a result, our primary concern is to ensure that overseas currency risk doesn’t start to dominate total portfolio risk.
Drilling down into asset classes, as a starting point, we tend to hedge back major currency (USD, euro and yen) overseas bond exposure into sterling, as the lower volatility profile of bonds means they can easily be dominated by currency volatility. For any emerging market bond exposure, where currencies can be particularly volatile but hedging costs can be very high, we tend to limit currency risk by limiting the amount of exposure to the asset.
For overseas equity exposure we are more relaxed, as the relative difference in volatility profiles between the equity and currency is less, though, just as with emerging market bonds, for emerging market equity the currency risk tends to limit the total exposure to the asset. For developed equity exposure, we step back and ensure that in portfolio aggregate, as mentioned earlier, an individual currency isn’t contributing too much to total portfolio risk. If it starts to, we can hedge more of it back into sterling.
It isn’t a science and we don’t pretend it’s straight forward. For example, BP is listed in the UK and so considered a sterling asset by the models, though its revenues are in US dollars, while BP will also have their own internal currency hedge programs in place. Gold is another example: quoted in US dollars but complicated as it often benefits from US dollar weakness, so we consider our US dollar exposure including and excluding gold.
Of course, in practice, we will often have a view on a currency direction but, due to the reasons outlined above, we won’t feel comfortable expressing that in the portfolio. However, where we do take a view is around the holistic impact of a currency on how risk-on or risk-off the portfolio is. For example, at the moment, sterling is behaving as a risk-on asset, rather than being driven by more conventional dynamics such as interest rate differentials. As a result, we have to be aware that our exposure to sterling also impacts the total degree of risk-on bias within the portfolio. So, keen to reduce currency risk generally, we will have quite a material exposure to sterling across the funds but, inadvertently, this is actually contributing to risk, albeit a different type of risk. Similarly, with our Japanese yen exposure, there is currency risk here but also the yen tends to act as a safe haven, so also has an impact on the degree to which the portfolio is risk-on.
In summary, it might sound ironic but, because currency risk is so complex, we try not to be too clever. It is very important to us to ensure that our currency exposure doesn’t drive portfolio risk. To do this we slice and dice the portfolio in many different ways, to try to understand the different types of risk implications.
