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Michael Sager. I’m a client portfolio manager with CIBC Asset Management.
In the current environment of central bank easing and low interest rates, where are the opportunities to add value in an active currency strategy? Certainly, central banks broadly across the world are easing policy and the interest rates are certainly coming down. Currency volatility has absolutely remained relatively low, although it’s picked up a little bit recently, but nonetheless it’s a very challenging environment for active currency investors right now, so experience is at a premium.
The challenge comes from the fact that returns are being driven primarily by a range of non-fundamental factors. Politics are at the forefront of that. You can think about U.S.-China trade war, you can think about Brexit, lots of others. It makes it difficult to analyze the long-term value opportunity in any asset class, and that includes currency, so the environment’s a testing one. The opportunity always comes in the ability therefore to identify fundamentally strong but cheap currencies, those currencies that are going to prevail in the long term and then position in favour of those and against overvalued currencies. That’s the opportunity, and you have to look through the short-term, day-to-day noise.
A lot of emerging market currencies have really strong long-term fundamentals and so as an asset class, emerging market currencies are really attractive to us. They still have relatively high interest rate carry on a number of them, they’re fundamentally strong domestic fundamentals in a number of currencies that I’ll mention in a moment look attractive, and a lot of them are cheap as well, so that’s a nice three-way combination of factors that are really attractive to active currency investors. Some of the more attractive ones include the Indian rupee, very good fundamentals, strong domestic demand or high domestic demand that insulates it, for example, from the U.S.-China trade war to a large extent. That’s important. The Indonesian rupiah is another good one, but at the same time there are currencies in emerging markets which are challenge, which are vulnerable — the likes of the Korean won. Korea is much more exposed to Chinese growth.
Chinese cyclical growth is weakening, and because Korea is exposed to China, it’s also in the headlights of the U.S.-China trade war, which is another big negative. So, it’s important again to be able to isolate which currencies in emerging markets are fundamentally strong and which have vulnerabilities and then position accordingly. It’s definitely emerging markets as an asset class, or current emerging market currencies as an asset class, that are attractive, but it’s important to understand where that attraction is highest and where there are vulnerabilities.
To the second part of the question, Brexit and the outlook for the pound, that really is a difficult one and it’s something that we have broadly steered clear of for the last couple of years. It’s important within any portfolio to use risk wisely, allocate risk to high-conviction ideas and themes because that’s where you’re going to have the most success adding value. We, along with frankly U.K. politicians, have relatively low conviction about the final outcome of Brexit. It seems that the probability of a hard Brexit has declined in recent weeks, but nonetheless there is a lot of uncertainty still swirling around the event, and that suggests that it’s better to avoid the pound at the moment and then wait until more clarity emerges and invest based on fundamentals. So, at the moment, the risk of being either long or short in the pound is not one that we’re being rewarded for. Therefore, stay clear.