The Big Picture THE BIG PICTURE: CURRENCY RISK: A (POUNDING) HEADACHE?
NET FUTURE POSITIONS ON STERLING
20 40 60
0
-120 -100 -80 -60 -40 -20
Jan 16 Jan 17 Net position (in thousand) Jan 18 Jan 19 Jan 20 Source: Commodities Futures Trading Commission
How could the outcome of the UK’s trade negotiations with the EU affect institutional portfolios?
Most institutional investors have by now positioned their port- folio to protect them against the UK failing to agree a trade deal with the EU.
Over the past year, almost 60% of UK schemes have reduced their exposure to London-listed equities in-line with the gener- al trend towards de-risking, according to Aon. This is a strate- gy that could protect them if the UK trades with Europe on WTO terms. But even a globally diversified equity portfolio could potential- ly be hit by the lack of a trade agreement if it is exposed to ex- change rate risks. This is particularly the case for euro-denom- inated investment portfolios, where converting revenue into sterling could become a lot more costly from January in the event of a no-deal Brexit. Some investors have already identified this risk. Indeed, the proportion of institutional investors who have hedged more
than 60% of their overseas equity exposure has nearly doubled to 42% from 26% in the past year. However, this still leaves a significant proportion of risk unhedged, which could prove costly, particularly for defined contribution schemes with a higher level of equity exposure. So far this year, the negative exchange rate effects of a potential no-deal Brexit have been relatively benign, largely due to a per- sistently falling dollar and interventions by the European Cen- tral Bank to prevent extreme euro appreciation, exchange rate risks are a two-way street after all. But with the clock for a trade deal between the UK and the EU ticking, short bets against the sterling are on the rise. At the beginning of November, asset managers and institution- al investors globally held close to 60,000 short positions against sterling, an increase of more than 2,000 net short po- sitions compared to the end of October. Over the longer term, short bets against the pound are far from the peaks seen in 2016, this could soon change, as the episodes of currency vola- tility seen during the summer last year demonstrate.
Issue 98 | November 2020 | portfolio institutional | 11
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