Home / How a strong greenback is impacting investor patterns

(pictured: Dori Levanoni) 

Whenever the US dollar spikes up or down investors around the world suddenly get interested in their currency exposures. Currency, it seems, is an after-thought asset class which happens to be, often, the first or second-biggest influencer of investment returns. That interest has been piqued right now.

Dori Levanoni, a partner, investments, at First Quadrant in the US, says that in the current environment where equities look fully priced and fixed income looks even riskier, liquid alternatives have become the new “other” asset for a portfolio. But they are competing with stocks and bonds more because of the current deficiencies of those major asset classes rather than because of the inherent characteristics of the alternatives.

Unconstrained bond funds are starting to show up on investors’ radars, Levanoni says, but bonds, of various kinds, which should be a safe haven, are not necessarily so. Too many people trade them, he says. And they don’t always behave as you’d expect. The behaviour of currencies, on the other hand, can more generally be explained in a standard supply-and-demand fashion.

When the US and Germany was downgraded, for instance, they subsequently outperformed other bond markets. There are other instances of “perverse” movements with bonds.

First Quadrant is a global quant manager based in Pasadena, California. It has about US$20 billion under management, just over US$1 billion of which is Australian sourced. It was one of the world’s first proponents of tactical asset allocation as a discrete strategy and the development of active currency management.

Levanoni, who says he has to travel a lot more when the US dollar spikes because of investor concerns about what to do, says that the more scared people become the worse are the decisions they make.

With its active currency strategies, First Quadrant expects to do three things:

• add some return to the overall portfolio, which will typically be about 100bps
• lower overall risk and manage the currency risk of the equities portfolio, and
• act as a tail-risk hedge for equities.

“When equities have their worst times, we will usually do extra well,” Levanoni says. “We provide an indirect or proxy tail hedge.” In the past 10 years, during the worst 10 single months for either the ASX 200 index or MSCI World, First Quadrant’s strategies were “strongly positive” on either eight or nine occasions.

“Our skill is in forecasting currencies by analysing supply and demand and who is trading them,” Levanoni says. “Currency is no more complex than any other asset class… Currency prices change because someone has traded them.

Australia’s super funds are not in a unique position with their consideration of what to do about currency. Although the Aussie dollar tends to be more volatile than some other major currencies, almost every big fund looks at its currency exposure versus the US dollar and considers whether or not to hedge. The usual default hedge is 50 per cent.

“People think it’s a ‘no decision’ decision, but it’s not,” Levanoni says. “It’s actually a very big decision. We’ve been hearing about the benefits of diversification globally for more than 50 years. That it’s a free lunch. But they were talking about equities, not currency… Currency is more volatile than bonds and about two-thirds as volatile as equities. In terms of standard asset allocations, equities are the biggest component, and bonds are big and so is currency.”

In terms of his discussions with clients, Levanoni says the first thing to do is to “pay attention” to the issue. Generally, this will lead to a decision to hedge. For Australian investors, generally the hedge should be a bit more than for other US or European investors, he says.