Has the sterling rally already begun?

Ben Raven - Director
Sterling has just posted its first quarterly gain against the dollar since June 2015, and continues to be significantly undervalued according to many industry professionals.
Oxford Economics believe the pound to be undervalued “on a wide range of valuation metrics”, whilst last week, Barclays highlighted that on one measure, sterling had only been cheaper against a basket of currencies during the depths of the financial crisis and the International Monetary Fund’s UK bail-out in the 1970s.

The Commodity Futures Trading Commission published speculative net sterling short positions at the end of March. These were close to record highs… 

Sterling has just posted its first quarterly gain against the dollar since June 2015, and continues to be significantly undervalued according to many industry professionals.
Oxford Economics believe the pound to be undervalued “on a wide range of valuation metrics”, whilst last week, Barclays highlighted that on one measure, sterling had only been cheaper against a basket of currencies during the depths of the financial crisis and the International Monetary Fund’s UK bail-out in the 1970s.

The Commodity Futures Trading Commission published speculative net sterling short positions at the end of March. These were close to record highs… 

According to Marvin Barth, global head of foreign exchange at Barclays, “to be that short when you’re this cheap seems like a mistake”. Mr. Barth also expects the triggering of Article 50 to initiate a ‘sell the rumour, buy the fact’ rebound in sterling as ambiguity over Brexit recedes.
Barclays, Nomura and Citi have all said near record bets against sterling would start to unwind if the initial constructive tone adopted by the UK and Brussels continued during Brexit negotiations and US president Donald Trump faced further hurdles implementing reforms.

Consequently, analysts at Barclays believe that sterling will rebound to €1.30 against the euro by early next year and $1.38 against the dollar within 12 months.

So what would this mean for your client’s portfolios?

Let’s consider a client invested in equities, with 50% in UK or sterling denominated equities, and 50% in overseas equities which are not hedged back into sterling. If the underlying equity markets (against which your client’s portfolio is benchmarked) were up +4% over the next 12 months, and sterling did indeed bounce back to $1.38 (approximately a +10% rally from the current $1.25) the client would suffer a loss of approximately -2%.
Let’s consider a client invested in equities, with 50% in UK or sterling denominated equities, and 50% in overseas equities which are not hedged back into sterling. If the underlying equity markets (against which your client’s portfolio is benchmarked) were up +4% over the next 12 months, and sterling did indeed bounce back to $1.38 (approximately a +10% rally from the current $1.25) the client would suffer a loss of approximately -2%.
The 50% allocated to the UK would be unaffected and the client would make the +4% on this half of their portfolio. However crucially, the overseas unhedged 50% would be subjected to the 10% move in sterling. This would work against any UK based investor and cause a loss of -6% on this half of their portfolio. The overall result would be a -2% loss (4% – 6%) for the client…
The 50% allocated to the UK would be unaffected and the client would make the +4% on this half of their portfolio. However crucially, the overseas unhedged 50% would be subjected to the 10% move in sterling. This would work against any UK based investor and cause a loss of -6% on this half of their portfolio. The overall result would be a -2% loss (4% – 6%) for the client…

Are you prepared for such a scenario? 

The asset class itself is irrelevant here; it could be equities, or bonds or commodities. The issue is that if you have UK based clients, with part of their portfolio invested in overseas markets, then they are at risk from currency fluctuations.
The asset class itself is irrelevant here; it could be equities, or bonds or commodities. The issue is that if you have UK based clients, with part of their portfolio invested in overseas markets, then they are at risk from currency fluctuations.
If you are recommending investment portfolios with unhedged exposure you need to prepare for the potentially significant losses your clients will incur as the pound recovers.

The currency juggernaut may have already turned around

This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Tavistock Wealth Limited.

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