BOX-OUT: WHAT TO DO?
The movements in foreign exchange and the divergence of monetary policy should spark investors to consider some changes to portfolios.
The most obvious change for sterling-based investors is to hedge their euro exposures. Downward pressure on the euro is likely to intensify in the coming months and years, driven not just by the advent of the ECB’s QE programme, which still has the capacity for further upside surprise in its scale, but also from the growing divergence in monetary policies between the US and Europe.
The Eurodollar rate plunged 1.3% on 26 February to 1.12, following yields lower. EURGBP was another big decliner breaking back to 0.728, levels not seen since December 2007.
According to Peter O’Flanagan, head of trading at ClearTreasury: “It appears the move has been exaggerated by rising US bond yields (following better than expected durable goods data), which are diverging from eurozone debt yields. The prospect of the ECB’s QE due to begin next month obviously means there will be plenty of demand for euro debt going forward, meaning yields are likely to continue to drop… this will likely continue as long as eurozone debt yields diverge from its counterparts.”
Given the direction of travel for the euro is likely to be downwards in light of the ECB’s explicit desire for it to do so, Aon Hewitt global head of asset allocation, Tapan Datta, says: “The euro will weaken further so the default position of investors should be to hedge their euro assets.”
Divergence also creates an asset allocation issue for investors. Unigestion’s Guilhem Savry, investment manager in the Cross Asset Team, advises investors to move towards more dynamic strategies in response to that divergence. “There is a beta issue emerging,” he says. “The performance of beta strategies over the last three to four years have been positive, but now it is more important to be reactive. Divergence in monetary policy globally means more volatility.”
Furthermore, with yields low and, according to ClearTreasury negative on two-year debt across almost all major eurozone bonds, the income effect many investors seek from their bond allocations has all but disappeared. Their protective power has also become less efficient.
“Investors should modify allocations to diversify ‘safe’ assets,” Unigestion’s Savry argues, suggesting CTAs as one alternative. “Trend following strategies have the ability to adapt quickly to situations as they change. This wouldn’t be a total substitution, but it is important to diversify the ‘safe’ allocation.”
BOX-OUT: GREXIT: ON THE BRINK
Although Greece has struck a deal to extend its current €172bn bailout by four months, is Grexit still a genuine risk and what impact will that have on investors?
Lukas Daalder, CIO at Robeco: “For Greece a Grexit would mean instant bankruptcy, for the eurozone it would be the loss of a reliable partner in the South-East of Europe, the doorway to Turkey and the Middle-East. A compromise is therefore the most likely outcome. In case of an escalation of the conflict, it will certainly have a negative impact on European stocks, although we are not expecting to see the kind of contagion we have seen in the past. Most of the losses will be borne by institutions who can take a hit.”
Niall Quinn, international CEO, Eaton Vance: “There is a small possibility of Greece exiting the eurozone however it’s not likely to happen in 2015, but it remains a longer-term risk that could cause further weakening of the euro and widening of spreads in peripheral European countries.”
Eric Lascelles, chief economist for RBC Global Asset Management: “It remains likeliest that Grexit is avoided, but the risks are undeniably growing. Much of the recent chest-thumping represents posturing to secure the best possible bargaining position. In a worst-case scenario, Greek banks would suffer and some shrapnel would lodge in the European economy, but with far fewer complications than had it happened in 2012.”
Andrew Parry, head of equities, Hermes Investment Management: “QE and ultra low interest rates (often negative) force investors to adopt risk and to be believers that the worst outcomes can be averted. Relying on real politick has worked before, but with the politically inexperienced Greek prime minister Mr Tsipras viewing himself more as a revolutionary than a statesman, we are dealing with an entirely new scenario.”
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