Currency: a zero-sum game fiduciaries are forced to play

The biggest decision facing pension fund investment committees this year could well be their position on currencies, particularly the greenback and the euro. The currency decision is never an easy one to make and at the moment it seems particularly difficult as politics is overlaid onto market fundamentals.

Last week’s IMF annual meeting, for instance, seemed to focus on the political aspect of China’s managed currency and whether, if it was managed up a little more quickly, it would improve global imbalances. The US certainly thinks so but the Chinese are wary.

The problem for fiduciary investors around the world is that currencies can deviate from fair value as determined by economic fundamentals for long periods of time, sometimes years.

There are several reasons for this, one of which is politics. Even in free-float economies, central banks intervene constantly to buy and sell their own currencies as a means of smoothing out interest rate pressures and as another tool in monetary policy. Where the currencies are fixed or managed, intervention is more blunt. Currency levels can be simply changed or allowed to move with markets in a governed fashion.

Another reason is that a second group of market participants will also be investing in currencies for reasons other than to make a profit. They are the export and import businesses, which need to hedge. Their purchases and sales of currencies will reflect the businesses’ underlying customer and supplier base rather than their views on future valuations.

A third group, traders, including hedge funds and global macro managers, will go in and out depending on views on valuations, trends and money flows.

Then there are the long-term investors who mix up protection of underlying portfolios, as businesses do, with shorter-term investment opportunities, as hedge funds do.

Because currencies are a zero-sum game, unlike other asset classes, global investors are forced to have a view not only on their home currency versus major ones such as the US$ and euro, but also, to a certain extent, on cross currencies as well, depending on the fund’s underlying portfolios.

Currency, if it is an asset class – some people still think its characteristics are too different for it to qualify – is not a decision the fiduciary investor can avoid. The investor cannot have no view.

The view, of course, can be outsourced to an active manager, which is becoming increasingly popular, or can be decided and fixed according to some middle-of-the-road benchmark, such as 50:50 hedged against one currency or a basket of currencies. But it is still a view for which the fiduciary’s constituency will wear the consequences.

The China RMB valuation debate is likely to continue to rage through to the next G20 Summit in Seoul, November 11-12, and probably beyond. The theme of this summit is ‘The G20’s Role Post-Crisis’.

It should be noted that the RMB is currently at its highest level against the US$ since 1993, having risen 2.3 per cent since June when the People’s Bank (China’s central bank) announced it was relaxing the dollar peg.

The currency is a big issue in China – much bigger than the declining value of the US$ is in the US. There is a currency report, often front page, in the Chinese newspapers every single day. Usually these reports quote a Chinese official saying words to the effect that the world’s and US economic problems are not due to the supposed undervaluation of the RMB.

The odd thing about this is that China is not suffering economically through the global recovery process, so why should the Chinese care about what anyone thinks of the value of its currency? Trade’s not drying up. Investment’s not drying up. Domestic demand’s certainly not drying up.

One economist says that the local RMB commentary reflects more the sensitivity China has over how it is perceived by the West. It would rather publicly argue its position than show a visible shrug of the shoulders to the world.

*Greg Bright is the Beijing-based publisher of Top1000Funds.com