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The world from the perspective of the US-focused investor looks pretty bright at the moment. The unexpectedly strong US economy, buoyant stock prices and the gradual revival in dealmaking have put Wall Street into an optimistic frame of mind about its home market.
“I would say that the vast majority of investors, my clients around the globe, when I asked about the US, they would say ‘I’m over-allocated to the US, but I’m going to allocate more capital to the US’,” Carlyle boss Harvey Schwartz told the Milken Institute’s annual gathering this week.
He shared the stage with, among others, Citigroup leader Jane Fraser, who shrugged aside concerns about high stock market valuations. She pointed to the two narratives that have driven stocks higher in recent months, noting that if growth remained robust, that would give stocks a reason to rally, while if the economy slowed and interest rate cuts were seen as imminent, equities tended to gain then, too.
Yet not all the clouds have been blown away, particularly for investors looking overseas. Geopolitical risk is a constant in investor conversations — as are the challenges in navigating the shifts in economies moving at different paces. The clearest expression of that is the return of currency hedging to the agenda.
“For a long time investors just didn’t have to worry very much about currencies,” said Karen Karniol-Tambour, co-chief investment officer at hedge fund Bridgewater Associates at the Milken conference. She said she had spoken to investors who talked up recent great investments — but rued how currency moves had distorted them.
The yen is the most obvious example, in the last month suffering heart-stopping swings against the dollar. It has moved as much as Y3 in mere minutes, on suspected intervention by the authorities to slow its slide. Karniol-Tambour, pointed to its effect on Japanese stocks: “Japan has been amazing — an incredible performer — if you’ve thought about your currency exposure and said, ‘I don’t want it’.”
Over the past year, the Japanese currency has fallen almost 13 per cent as local policymakers have only very gradually inched away from super-loose monetary policy while the dollar has been buoyed by higher interest rates for longer than had been anticipated.
This has left an unhedged dollar-based investor tracking the benchmark Topix index with a total return of 17 per cent for 12 months. Those who were fully protected managed something just over 30 per cent, outperforming gains from the S&P 500.
Hedging can be a means of improving returns, but for many, discussions have been about protection from the risk of unforeseen shock. “It’s not that investors think the dollar is going to depreciate any time soon. They’re using it as a hedge against geopolitics rather than taking a bet against other countries,” said Elizabeth Burton, client investment strategist at Goldman Sachs Asset Management.
Burton says about a third of institutional investors hedge currency risk. “[They] may not need a currency hedge right now, given dollar strength, but implementing it now could put you in a better position if it weakens down the road.”
It’s a difficult balance for investors more used to thinking of the greenback as a haven in times of trouble and as a beneficiary of the US “exceptionalism” argument that has developed over the past decade as its markets have outperformed others.
Still, big swings for the dollar in either direction have the potential to upset investment strategies. Bank of America’s analysts this week pointed to the need for US companies to consider their currency exposure, too, in case the dollar gained further — which would weaken their earnings once overseas income is translated into dollars.
“While our forecasts still look for eventual dollar weakness over the medium-term, the turning point has become harder to time,” they wrote to clients. “The case to hedge dollar upside risks for the rest of the year has materially grown for US corporates.”
Current contracts to buy the dollar in the future imply a discount to the spot price against many other major currencies. That means the dollar is priced at a lower level against, say, its Canadian counterpart for transactions for November delivery than now. BofA’s team calculate that based on recent pricing, there is about an 80 per cent probability that buying greenbacks in six months time with the loonie, as the Canadian currency is known in markets, would pay off.
Hedges cost but the more the world’s big economies move at different paces, the harder it is to justify doing without them.
jennifer.hughes@ft.com
