While investors are focused on the volatility in equity and fixed-income markets, another factor having an impact on returns may have fallen off the radar.
The return of currency risk has already gained prominence with broad debates over the future of the euro, not least what would happen to euro-denominated private sector debt in the event of a sovereign default. In Hungary, some of the more tangible consequences of foreign exchange volatility are unfolding, with holders of foreign currency loans suffering in the face of forint weakness.
Hungary may be offering a warning for what a disorderly eurozone default might look like as it re-engages with the International Monetary Fund over a bailout of its ailing economy.
The repercussions of recent currency swings will have had an impact on investors’ portfolio performance. Over the past 12 months, few would be surprised to learn the Nikkei 225 index of Japanese leading shares has struggled, posting a loss of 20.10 per cent in yen terms.
But despite frequent efforts by the Bank of Japan to hold back the appreciation of the country’s currency, the strengthening of the yen against sterling has meant that, in sterling terms, the index has fallen by a more modest 13.48 per cent, according to FE Analytics.
Any absolute loss will hardly comfort investors in Japan who saw the Tohoku earthquake threaten global supply chains and severely damage the power grid. Nevertheless, it does serve the illustrate the importance of understanding currency shifts, particularly in the high-volatility, low-return environment that many predict for 2012.
For FE Adviser Fund Index panellists, trading between currencies is difficult to achieve, considering the portfolios can only be rebalanced twice a year. This has meant some are sceptical about the significance of currency to a long-term investment strategy. “When we invest in funds we do not invest for the short term and so we are not overly concerned with currency risk,” says Graham Toone, head of research at AFH Independent Financial Services. “We see it as part of the macro noise. It is more a short-term trade than a long-term investment strategy.”
With macroeconomic uncertainties and extraordinary action taken by monetary policymakers dictating markets, this unwillingness to make currency calls is perhaps unsurprising. However, though there are potential pitfalls, there are also some possibilities to reverse recent trends.
The most important could be the end of quantitative easing. Since June last year, when the Federal Reserve finished its $600bn second round of QE, the market has been rife with rumours that further economic weakness would necessitate a third stimulus. But if recent positive jobs data proves an early sign of a broader strengthening of the American economy, pressure may well be removed from the Fed to intervene. That would be a strong positive sign for the dollar.
Similar impetus could be given to sterling if the Bank of England brings its asset-purchase programme to a close in the first quarter of this year, as some expect.
The apparent lack of conviction from investors may reflect broader fears that politicians may struggle to overcome partisan and ideological divides to find comprehensive solutions to current economic problems. What seems certainly the case is that while these concerns exist perceived safe havens are likely to continue to trade at a premium.
Data supplied by FE