G20 PUTS FX MARKETS IN SHARP FOCUS

DIRECTOR OF THIRD PARTY DISTRIBUTION, ETF SECURITIES

CURRENCIES are currently very much in focus. Bizarrely, however, many investors shun direct currency exposure because they view currencies as being more volatile compared to other asset classes. This leads investors to play currencies through their asset allocation decisions rather than trading the foreign exchange markets directly. Indeed much of the money that has been poured into emerging market debt is quite possibly invested for the currency rather than for the debt exposure.

However, there are a number of good reasons why investors should take on direct currency exposure. It provides portfolio diversification thanks to its low correlation to other asset classes, meaning that it can serve as a buffer even during the most turbulent times for the financial markets. At the same time, investors can de-risk their exposure to currencies through fully invested vehicles.

This implies taking money out of other asset classes and redeploying to direct currency exposure. Given currency’s diversification properties, this would seem a logical way to allocate capital. The current year has been one in which the FX markets have seen strong trends, driven in part by changes in risk sentiment.

With currencies at the top of the agenda of the G20 Presidential Summit on 11-12 November, there are possibly two key areas of interest for currency investors:

• More quantitative easing: if markets decide to punish the printers, then this could result in pressure on the US dollar.

• G20: against the background of currency wars, there may well be increasing pressure on the authorities of emerging market currencies that are seen to be subject to manipulation.

Lastly, investors should carefully consider currency valuations. Among the G10 currencies, the Australian dollar – the star of the carry trade – is trading at the very top end of its 20-year range against the US dollar.

The Aussie dollar hit parity with the US dollar earlier this week after the Reserve Bank of Australia (RBA) unexpectedly raised the cost of borrowing. The average level for the pair is US$0.70 but the Aussie dollar has been strengthening in 2010, which appears to have been linked to Chinese demand for commodities. However, the warning signs are flashing for the Australian economy: high personal debt levels, average house prices more than five times average incomes and mortgages of close to 100 per cent readily available. It all sounds vaguely familiar.