By Paul Golden
How the mighty fall only to rise from the ashes once more: after the January-February sell-off in emerging markets (EMs) current-account deficit nations – sparking the apparent spectre of the Asia crisis – the likes of the Indian rupee, Brazilian real and the Indonesian rupiah have staged a massive rally, thanks to decisive monetary action, excess global liquidity and low volatility.
ABN Amro’s FX market review for May observes that EM currencies have been in vogue since the beginning of this year and predicts the Goldilocks macro environment for these currencies will continue for some months.
According to the bank’s head of FX strategy Georgette Boele, volatility will probably remain relatively low as the Fed continues to anchor long-term interest rates and EM central banks would likely intervene if currencies became too strong.
And yet, high-net-worth individuals (HNWIs) remain cautious on EM FX exposure, even as traditional real-money institutional investors take unhedged position in local credit and rate markets, amid expectations of currency strengthening in the coming years amid GDP and productivity gains.
However, Citi has not noticed any notable shift away from the leading currencies during the past 12 months among HNWIs, explains Iain Armitage, head of investments for EMEA.
“Some clients have utilized their international investment portfolio to overweight exposure in currencies they believe are set to strengthen, but they are more often focused on the risk/return characteristics of the particular asset class,” he says.
These clients are predominantly invested either in dollars or the currencies of the countries they are domiciled in. Where they have exposure outside of these currencies, it is often hedged back to the dollar or their base currency.
“This ensures that the returns they are targeting are not eclipsed by an adverse movement in FX rates and makes additional sense in the current market environment, where the cost of purchasing such protection is at all-time lows,” adds Armitage.
“We also recommend that clients consider the use of FX as an asset class in itself and look at strategies to generate returns from such phenomenon as volatility, trend or momentum in rates.”
As asset markets in EMs expand and deepen, he feels it is inevitable a greater share of investors’ portfolios will gravitate to these opportunities, which include cash holdings – but only over the longer term.
Alan Mudie, head of investment strategy for Société Générale private banking, says clients in EMs tend to favour the US dollar as a point of reference. “However, there is also growing awareness of the diversification possibilities of the renminbi as China begins to liberalize its capital account, although it will be many more years before the currency is freely tradable and convertible,” he says.
Richard Laffoley, head of islands treasury at Lloyds Bank international private banking, says: “I would say that our typical client is risk-averse when it comes to currency speculation and as a consequence will normally retain their cash assets in the currency of their earnings and expenditure.
“Diversification of base currencies is not a service that we currently provide, as FX markets are very fickle and subject to high volatility and fluctuation. Should a client wish to diversify their currency holdings, we will endeavour to provide a suitable product in that currency.”
Mudie adds that his bank encourages clients not to simply gravitate towards currencies they think have short- or medium-term return potential. “There are several sound reasons why a client might change their base currency – for example, succession planning [if the next generation are living in a different currency zone] or a change in the focus of their business interests,” he says.
JPMorgan’s clients are overwhelmingly exposed to the dollar, followed by the euro and then equal amounts of sterling and the Swiss franc, states Stephen Jury, global head of FX and commodities. “There has been a shift towards lifting hedges in dollars for euro, sterling and Swiss franc clients over the last 12 months, as tapering starts to push the dollar higher,” he says. “Admittedly, the pace of appreciation has slowed considerably in 2014 as US 10-year yields have reversed course and actually traded lower, but we expect this to change in the second half of the year.”
To protect multi-generational family wealth against currency devaluations, inflation and a persistent trend of a dollar decline, he thinks clients should hold a small percentage of their portfolio in baskets of other currencies. “Demand for renminbi and the Singapore dollar is very different,” says Jury. “The latter is a stable, managed float that holds attraction as a fairly liquid, safe-haven currency, while the former has seen steady demand and investment flows for the last few years.
“The renminbi recently began a modest depreciation after the People’s Bank of China signalled a desire to introduce a change to the one-way carry-trade mentality that had sucked in substantial investments. Until the Chinese government moves to liberalize the currency market and introduce a free float, we would expect the upside momentum and consequent demand to continue.” It seems HNWIs remain a risk-averse bunch.