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Will the currency wars have long-term side FX?

The raging global currency war has created uncertainty about investment opportunities and about which areas will be hurt the most. Are there geographical areas that are best to avoid amid this currency volatility and areas advisers are favouring and avoiding as a result? And then there are the obvious knock-on implications for other asset classes, such as gold.

Currency fluctuations are part and parcel of being invested in foreign markets but, typically, it all comes out in the wash as underlying companies are global in nature. John Husselbee, CEO of North, believes that is still the case, despite the heightened FX volatility.

However, investors may see dampened returns in the short term from US funds as a result of dollar weakness, while UK equity income funds receive a large portion of their income these days from companies with dollar dividends. But one of the key areas of concern with regards to the impact of currency is Japan.

Husselbee says: “Ahead of the expected QE2 from the US, the dollar weakened in October, the beneficiaries of which were the yen and the euro. European equities provided a good return over the month as a result. The strengthening yen was not as helpful for Japan, which made an ineffectual attempt to depreciate its currency. With many Asian markets pegging their currencies to the dollar, its weakness and the yen’s strength is making Japanese exports look less competitive.”

Gordon Lowson, head of money markets at Standard Life Investments, also expressed concern over Japan’s situation in the group’s recent global market outlook. He says: “The noticeable weakening in the Japanese economy over the past few months has been attributable to the ever-appreciating value of the yen.

“The scope to galvanise the faltering economy through fiscal or interest rate policy initiatives is severely constrained by the extent of government debt and by the already low level of interest rates.”

As a result, in September, for the first time in some six years, the authorities decided to tackle yen strength through direct intervention to sell the currency, he says.

“It risks retaliatory action from other countries anxious to give their economies a boost from currency manipulation. However, it’s a risk the Japanese authorities have been willing to take.”

Despite the need for a weaker yen and actions taken to bring it about, Lowson’s colleague Ken Dickson, investment director of currency at SLI, remains convinced of a strong yen to come, saying there is “a good chance of the all-time lows in the US dollar/yen being tested”.

In light of Japan’s currency issues, Husselbee believes the obvious action for investors in Japan is to ensure their investments are hedged.

While there may be areas to avoid or take a cautious view on amid the currency war, there are also beneficiaries.

Husselbee says: “Gold could appreciate further as it benefits from currency volatility and as the richer nations look to diversify their savings away from bonds.”

There are also direct ways to play the rising level of FX volatility, with several hundred dedicated funds in this arena available in the offshore market. That said, choosing which region and which currency could be daunting for many investors and their advisers.

In Financial Express’s FSA offshore recognised funds database there are four currency-specific sectors. The offer-to-bid returns, rebased into sterling, vary from a loss of almost 6 per cent to a gain of more than 7 per cent over the three months to November 3.

Among the best performers over that short timeframe are those exposed to the euro, while over one year the best were exposed to areas such as the Australian dollar, the Canadian dollar, Swiss francs and emerging economy currencies.

Global bond funds, which typically offer returns of gilts plus currency, may be a simpler choice. Which goes some way to explain the recent popularity of the sector. According to the IMA, it was the best retail area in September, completing the highest-selling quarter for global bonds on record.

The sector saw net sales of £348m in September and amounted to £947m over the quarter .

Still, choice in this sector is not that straightforward. Over the same three-month period examined for currency funds, global fund returns ran from a high of 10.87 per cent to a loss of almost 5 per cent. And the majority of those sitting at the top of the pile have a European focus, while over one year to the same end date, it is funds exposed to the emerging economies that fared the best.

How long the euro-focused funds will be at the top is a question investors must ask if they are looking at recent performance. Dickson says the euro is starting to look expensive as it benefits from dollar weakness and a feeling that most of the bad news concerning sovereign debt is already discounted.

“The currency over-valuation for non-core European countries is significant at the current euro exchange rate.

“This, combined with new evidence of a slowdown in German economic performance and the expectation of a gradual withdrawal of ECB market aid, would lead us to anticipate the euro strength to be relatively short lived, with upside momentum running out as the year comes to a close,” he says.

On the other hand, Dickson believes now the UK has revealed its austerity measures confidence will return to the UK and sterling will begin to appreciate towards the end of the year.

The mechanics of the FX markets always has many factors but it has been some time since we have seen the kind of machinations economies are taking to depreciate the value of their respective currencies in order to prop up growth.

Such is the level of global concern that the FX issue is likely to be a key topic at the G20 summit in Seoul. Of course, whatever happens at next week’s summit, what they say and what they do will be two very different things and the impact this currency volatility will have on investments in the near term is unlikely to be over any time soon.

Kira Nickerson is a freelance journalist

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