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Is sterling now undervalued?

Is sterling now undervalued?

For the first time in more than three years, investors have started to go net long on sterling, according to Edward Smith, head of asset allocation research at Rathbones.

‘A few months ago investors were unsure about sterling but in the last month they have gone net long again,’ he said. ‘It is the first time we have seen this in three or so years.’

This is due to a combination of attractive valuations, Bank of England monetary policy and investors viewing the expected negative impact of Brexit as an exaggeration. And compared to other currencies, the dollar and the euro look overvalued, Smith argues.

‘We do not hedge our currencies too much because it can be tricky in private client portfolios and we do not tend to take explicit positions in currencies. So, thinking long term, we believe it will favour sterling and short term we are bracing ourselves for more volatility.’

Also nerving for a similar environment is Mihir Worah, CIO asset allocation and real return at Pimco. Rather than the UK, his strategy is to prepare for uncertainty in Asia.

‘We were long the dollar and that did well and we got ahead of 2017 when the Fed actually started being more dovish. So currency positions are lower, we are not taking a lot of risk in any one sector and our largest currency positions right now are small,' he said

'We are still modestly long the dollar but it has changed; it is against the basket of Asian currencies and we think that is a good diversifying position against if something goes wrong in China,’ he explained.

 

Favouring the yen

Ugo Lancioni, head of currency management at Neuberger Berman, pointed out that the field has been attracting more investors, helping to drive assets for his team from $8.5 billion (£6.4 billion) to $35 billion in the past five years.

‘Inflation has been missing for some years,’ Lancioni noted. ‘In the current environment returns in fixed income will not be as good as they could while equity returns have been very good for years and this will change at some point. This creates a good environment for currency investment.’

While still positive on sterling, he remains wary of the impact Brexit might have on the currency. He has therefore turned his attention towards the yen and Canadian dollar.

Elsewhere, he finds the Swiss franc and the Australian dollar expensive, preferring Scandinavian currencies instead.

Another manager who likes the yen is Gareth Gettinby, multi-asset manager at Kames Capital.

‘To be safe, a currency needs to have strong liquidity as well as a strong budget position and current account surplus. Both the yen and Swiss franc fulfil this criteria, but the yen is cheaper,’ he said.

Despite the political tension between Poland and the European Union, he is also long the Polish zloty.

 

Sterling short

Not everyone is positive on sterling. Gary Fowler, investment director at Standard Life Aberdeen, argues that although the pound currenlty looks cheap, the downside risk is larger than the potential upside.

Across his firm’s multi-asset target return portfolios there is a tendency to be long yen, Swedish krona and Indian rupee, while holding short positions in sterling and the Swiss franc.

According to the investment update from Standard Life on Gars in September however, the strategy preferring the US dollar to the pound detracted from performance.

This was mainly due to the Bank of England hinting at rate rises (which did take place) and signs of Brexit negotiations moving forward. During the period, the Swedish krona versus the euro position also detracted from performance.

But, like many others, Fowler said the team uses currency largely as a diversifier and for the carry return benefits, not as a means to achieve strong returns. He added that, largely due to monetary policy changes, there is now less risk in FX positions compared to a year ago, 

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