Christopher Aldous, head of asset management and distribution at Charles Stanley answers why Charles Stanley is trimming sterling hedges.
'Each day, another client reads the headlines and asks whether a market collapse is looming. We don’t think so, but with more uncertainty in the air, our dynamic asset allocation process comes into its own.
Since summer, we’ve seen central banks and monetary authorities all around the world shift away from easy money and low rates. Their attitude is that interest rates should be ‘normalised’ upwards from ultra-low levels.
Both developed and emerging markets have hiked, including in the UK, US, Canada, Norway, India, Mexico, South Africa and Saudi Arabia.
The European Central Bank is winding down its money creation program and Japan has reduced its bond-buying program. Coupled with this, we have seen purchasing manager indices falling slightly in the US and Europe, putting a dent in expectations of continued strong global growth (if only a small one).
All this makes us reflect on our current broad ‘risk-on’ and US-centric allocation across the various model portfolios.
Our bullish stance on equities has long been underpinned by an important valuation prop: the yield gap. Although US rates are creeping upwards, and other countries seem hell-bent on following suit, the prop remains generously supportive at almost 4% (MSCI AC World versus Barclays Aggregate Global Bond index).
In view of this, we’ll hold our headline risk exposures at current levels for the time being, but we are becoming nervous about potential currency impacts on portfolios, which are all sterling-based.
Until recently, our yen exposure was 50% hedged, while our USD exposure was 30% hedged. An unhedged position might now be smarter, as the yen tends to be a safe haven and appreciates whenever it looks as though the sky might fall in. It’s also at the bottom of a near-term trading range and appears more likely to rise against sterling than to fall.
To make the change, we’ll be switching our holdings of Lyxor JPX Nikkei 400 GBP hedged ETF into x-trackers JPX Nikkei 400 Ucits ET, which will save us around 5bps of the ongoing charges figure.
Our currency hedges are about risk management. We learnt long ago that currency speculation is a mug’s (or a true specialist’s) game. Our strategy is to apply a hedge that reflects a pair’s position relative to their trading range.
So, if the dollar is strong against sterling (for example, down at around $1.20), we might apply a full hedge. At the other end of the scale, we would be unhedged. As we’re currently bang in the middle of the range, we are, perhaps unsurprisingly, 50% hedged.
To change the hedge on our US equity exposure, we will be selling Vanguard S&P 500 ETF and reinvesting into x-trackers S&P 500 ETF 2C GBP Hedged for a very small extra cost of 2bps for the hedge.
We have also been looking at our lower risk multi-manager models, which have historically made significant use of alternatives – such as absolute return funds – as a fixed income proxy. While the best of these have shown defensive characteristics, holding them has been something of a charitable exercise on our part, and they have not pulled their weight over the past couple of years, compared to fixed income.
Having finally run out of patience, we have now booted out our holdings of Standard Life Gars and reinvested the proceeds in Investec Diversified Income.
Few other underlying holdings have been changed recently, but we are carefully watching for the point when US asset values
top out and the value embedded in some of the emerging and Far Eastern markets come to the fore.
Asian tech looks very cheap compared to its US counterpart, but it’s hard to access via passives unless you are prepared to buy an expensive swap-based product. We haven’t taken the plunge yet, as our ETFs providing US exposure to areas such as robotics and cyber security continue to perform well.
Part of our central thesis is that the huge pace of development in the tech sector will drive indices further, even when some sectors are falling.
The story isn’t over yet!'