New world order suits diversification

Currencies have always been an important source of diversification in private investors’ portfolios, but they have also become strategically important assets over the last couple of years.

“Clients are increasingly realising that having a diversified basket of currencies is not just an investment but a strategic issue on the longer term,” says Ivan Leung, chief investment strategist of JP Morgan Private Bank in Asia. Typically the money that wealthy individuals invest with JP Morgan is US dollar centric. That has made sense in the past, but the financial crisis has dramatically changed the perspective on the world economy, he says.

“Historically, during any crisis in emerging markets the US dollar was viewed as the safe heaven, as investors were exposed through their local business or local investments to domestic currency, which was considered higher risk and higher return. Today we firmly believe that clients need to diversify away from their home market but not to be overly US dollar centric, because we are in a very different world, in the “new normal” and we have to think broader,” he says.

While Asian and emerging market currencies are more volatile, the growth prospects and the balance sheets of emerging markets are much better than those for more mature markets. Clients should therefore hold a mixture of Asian currencies, which they feel more comfortable with, as well as developed market currencies, says Mr Leung.

“Even though investing in developed currencies tends to be a zero sum game over the long run, successful emerging currencies can be more of a one way story (ie the Japanese yen from 1970 to 1990). We all know that whenever there is a crisis, emerging currencies like the Korean won will fall more than say, the Australian or Canadian dollar, but over the longer-term, Asian currencies should be appreciating against developed currencies,” he says.

“With the recent decision by China to introduce ‘flexibility’ to the renminbi, an appreciating Chinese currency further supports the case that regional currencies should rise from their current cheap valuations,” adds Mr Leung.

“Once we have identified the right [currency] view, we try and highlight with clients what is the best investment vehicle to monetise that particular view. Clients do not necessarily need to a hold a FX structure to implement that.”

Spot transactions or structured products are common ways to implement FX hedging. A structure often takes the form of short-term dual currency deposit, which can allow clients to achieve a higher rate of return than simple deposits by taking advantage of currency fluctuations.

“We always emphasise that investors should use FX products and commodity currencies to diversify their portfolio and to hedge against currency movements and inflation,” says Elaine Wong, head of advisory and sales Hong Kong at Credit Suisse Private Banking.

“Most of our clients only do spot transactions, but in this climate, they also do structures because they want some sort of protection and customisation,” she says.

Using a basket of currencies, maybe equally weighted, such as the Bric (Brazil, Russia, China India) ones, investors can use structures which offer capital protection on the downside and on the upside they give a participation or leveraged participation. These types of structures have a longer maturity date of a year or longer, and are quite popular, says Ms Wong.

In the DNA

“Foreign exchange is embedded in the DNA of the Asian investors,” believes Bruno Lee, regional head of wealth management, Personal Financial Services, in Asia Pacific at HSBC Bank.

“Pacific Asian countries are export oriented and a lot of the Asian mass affluent customers may be business owners, work in multinational companies, travel, or have children in overseas education. FX on a relative basis is a simple product and people have been exposed to it for a long time. With market volatility, customers find that there are opportunities to get a higher yield currency,” he says.

The Australian, New Zealand or Canadian dollars are some of the favourite currencies customers want to hold. “These are commodity rich countries and there is an anticipation that if the global economy recover, the demand for commodities will increase, therefore supporting these currencies,” he explains. Australia, which has been relatively less affected by the global crisis, started increasing interest rates last October. Canada followed in June.

While everybody is avoiding the euro, some Asian currencies are providing very attractive yield, like the Indian rupee or Indonesian rupia, says Mr Lee.

Ivan Leung, JP Morgan Private Bank