Brave decisions needed on sterling exposure

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Having fallen off a cliff after the Brexit vote, the pound rallied at the start of September as data from the private sector signalled a better-than-expected economic outlook following a slump in July.

Sterling touched $1.33 against the dollar on the latest statistics from the purchasing managers’ index for manufacturing.

Compare that with sterling’s performance on 24 June, when the pound fell more than 10 per cent against the dollar, reaching $1.32 from $1.49 on referendum day. It hit a low of $1.28 in the first week of July.

Neuberger Berman foreign exchange and fixed income portfolio manager Ugo Lancioni says the recent rally has not been “massive”.

He says: “Implied volatility in the sterling market has collapsed, so it seems the market is not pricing in any dramatic scenario in the coming months.”

Lancioni questions whether the depreciation of sterling is excessive relative to the expected impact of Brexit.

He says: “From an investor perspective sterling has discounted too much on the negative Brexit impact and the short position represents a risk.”

Neuberger Berman had a “positive positioning” on sterling the day of the referendum result and has since added to this slightly. Lancioni says: “But that doesn’t mean I am positive on the UK economy as over the long run Brexit is going to be negative for the UK economy.”

Canaccord Genuity Wealth Management deputy chief investment officer Justin Oliver expects sterling to suffer “continued erosion” owing to the lack of clarity over Brexit timelines.

He says: “We have been underweight sterling assets since before the vote, so that has been beneficial for us.

“The path of sterling will gradually be undermined as weaker data will come through and whether we’ll have a ‘soft’ or ‘hard’ Brexit.

“Sentiment towards sterling is at a low ebb, and while such a position is often an opportune time to maintain a contrarian stance, it is hard to see sentiment shifting suddenly in this case.”

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Contrarians do exist, however. Rathbones head of multi-asset David Coombs reckons sterling is undervalued, though he has not changed the exposure in his fund after the recent rebound.

Coombs says: “Currency will continue to be volatile and weaken in the short term.

“However, we still have a lot of exposure in our funds and we still believe in having currency exposure in multi-asset funds as overseas investors will focus on Brexit after the negotiations.”

AJ Bell investment director Russ Mould says if sterling maintains its recovery, the worst-hit sectors that underperfomed after 24 June, such as those focused on consumers, will reverse their trend.

He points to the FTSE 250 for a possible mid-cap rebound, and the FTSE All Share, which he says has many big retail names that should benefit from a stronger pound.

Consequently, funds with retail brands in their top 10 holdings, such as the JOHCM UK Dynamic fund, should benefit from a sterling rebound.

BNY Mellon’s Investment Insight head of currency Paul Lambert says: “The challenge for us is the positioning. We recognise the market has a short pound position, but in the absence of momentum, that position gets squeezed. We won’t be adverse and go neutral but we’re still short and taking advantage of the volatility, although prices are falling a lot.”

Oliver says it it is difficult to find any attraction in alternative currencies right now and warns against any short-term currency switching decisions.

He says: “The euro has challenges as well. You don’t want to buy Japanese yen as more stimulus from the Bank of Japan is underway. You need to be careful if you are switching and getting out of sterling; the question is where you are going next. You need to make sure you have a good conviction call if you do that.”

Oliver points to emerging markets currencies as a potential bright spot, saying he has added to the Indian rupee despite nervousness at mass re-switching to the region by many of his peers.

TwentyFour Asset Management fund manager Chris Bowie expects the next move by the US Federal Reserve to be key for sterling.

He says: “If a US rate rise happens, and the Bank of England possibly cuts rates further, I’d expect a stronger dollar versus the pound.

“However, if the UK economy continues to surprise on the upside as it has done recently, it is certainly possible that the pound could recover to $1.35 or better.”

Mould adds: “Picking currencies at the moment is a dangerous game. The foreign exchange market is incredibly difficult to second guess, so allocating to currency is a brave thing to do.”