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A cura di Ludovic Colin di Vontobel AM

That’s the question from the back seat of the car that every parent has heard hundreds of times. Since the Fed rate hike in December of last year, 2016 has seen the market sitting in the back seat and Janet Yellen in the role of the parent in the driving seat patiently replying, “Just a little bit further.” The view out of the window remains the same yield-starved desert and the slow drive towards a Fed rate hike looks likely to last until December this year (or a little bit further). So, is there anything that changes when nothing seems to change? In a world of zero and negative interest rates, central banks still need to react to macroeconomic challenges. As a result, they have taken to using currencies as a monetary tool. There are several examples of this:

  • The Swiss National Bank pegging the Swiss franc to the euro, only to drop it four years later causing widespread market turbulence.
  • The Bank of Japan lowering the Japanese yen in an attempt to save their export industry and stop deflation.
  • The Chinese Central Bank continuing to allow the renminbi yuan to devalue. A sign that China is finding it difficult to deleverage its economy.

The benefits of actively managing currencies in a portfolio can be summarised in three ways:

  • Reduce the long-term risk profile of a portfolio. By hedging credit exposure with currency instruments, investors are in the position to reduce risk when liquidity disappears from other asset classes. For example, during the credit market turbulence in February of this year, currencies remained liquid.
  • Extract relative value opportunities through currency related macro themes. This was evident when the oil price slide impacted the Russian rouble vs. Turkish lira in February.
  • A powerful source of diversification. Currency correlation to other assets classes is rich in information and the correlations change over time. By actively acting upon, investors can improve their portfolio diversification, e.g. Japanese yen and US Treasuries are highly correlated when interest rates in the US or Japan change. When the investment case of emerging markets is strong, local currency is a good way to reduce or enhance the exposure to emerging markets.

The lack of shifts in interest rates are being pushed through into currencies. With minimal changes in interest rates, they are the proverbial duck above the water; while currencies are the feet, paddling away underneath. This provides fixed-income investors with a source of potential outperformance. We believe investors should aim to eliminate passive currency risk from their portfolios and replace it with an active currency allocation, thus extracting value from a yield-starved desert.

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