As central banks cut interest rates in response to slowing economic growth, adding value via a currency strategy is no easy feat.
Though currency volatility has remained low relative to that of equity and bond markets, “it’s a very challenging environment for active currency investors right now, so experience is at a premium,” said Michael Sager, vice-president and client portfolio manager, multi-asset and currency management, at CIBC Asset Management in a late-September interview.
Particularly challenging is that non-fundamental factors, such as geopolitics — including Brexit and trade tensions — have been driving returns. As a result, “you have to look through the short-term, day-to-day noise,” Sager said.
He finds opportunities by identifying and positioning in “strong but cheap currencies,” which he says will prevail in the long run relative to overvalued currencies.
Emerging markets offer examples. Along with being cheap, emerging market currencies have strong long-term fundamentals and relatively high interest rate carry. “That’s a nice three-way combination of factors that are really attractive to active currency investors,” Sager said.
He cites the Indonesian rupiah and the Indian rupee, the latter of which has “high domestic demand that insulates it, for example, from the U.S.-China trade war to a large extent — that’s important.”
In contrast, he steers clear of emerging market currencies that are vulnerable, like the Korean won. “Korea is much more exposed to Chinese [manufacturing] growth,” which is weakening, he said. “Because Korea is exposed to China, it’s also in the headlights of the U.S.-China trade war, which is another big negative.”
Successfully adding value through currency requires an ability to make distinctions and position accordingly, he said. Though emerging market currencies are attractive as an asset class, “it’s important to understand where that attraction is highest and where there are vulnerabilities.”
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