Serious Money Chris JohnsOne of the ways in which one or two global fund managers have been mugged by the markets this year is via their asset allocation and currency decisions.
If you thought stock picking was tough, you should try deciding between different asset classes and/or regional bets within equity markets. And then there is the hedging decision: how is any sentient investor supposed to decide whether or not the dollar is likely to fall or rise? Or any other currency?
Few people would have laid their bets on Switzerland as one of the world's best performing equity markets in the year to date. Yet Swiss stocks have risen, on average, by over 28 per cent. Of course, even these healthy returns have been massively exceeded by equities in the Middle East. The Dubai Financial Market Index is up 186 per cent while Saudi Arabia, Abu Dhabi and Kuwait all have returns in the 70-80 per cent range.
Few mainstream money managers will have participated in these oil-dominated markets. Indeed, size, liquidity and other constraints mean that these sorts of investments are often for the specialist managers. And, with a reminder about risk, not all oil-rich countries have provided super returns - the Venezuelan stock market is down 40 per cent.
While it would have been nice to have had all your money in Dubai, it would have been a rather risky bet, one that most professional money managers would rightly have been reluctant to place, at least using money belonging to widows and orphans.
In the fund management game, having no investments in the world's best performing equity market has, for once, not caused any pain, not least because the weighting of the Dubai market is so small.
According to survey data, most investors have stayed well clear of the US equity market this year. Of course, this is a much bigger bet than the decision to avoid Dubai. The US comprises over half the world's equity market capitalisation.
This is the one that we have to get right and, in terms of share price performance, the average fund manager's call to underweight the US has been spot on. The S&P 500, for example, is virtually unchanged so far this year, as is the Nasdaq, while the Dow is slightly down. Compared to German and French returns of around 18 per cent, the decision to avoid the US looks like the right one. Although, not so fast; to make these comparisons sensible, we have to put them in a common currency.
For example, let's look at German, French, UK and US returns in euros. Most people will be surprised to learn that the best performing market out of this group, by a whisker, is the UK (19 per cent plus). But thanks to the dollar's rise, particularly recently, that flat performance by the S&P in dollar terms is transformed into a near 17 per cent rise when measured in euros. That's still an under performance when compared to European markets but the gap is very small. Anyone underweight in the US and unhedged, must be growing very nervous about the next couple of months. It won't take very much to turn the US market into an outperformer.
Serious Money's existing bet on the US market is, to be fair, a straight contrarian investment: we like the US because nobody else does. We did not make an explicit currency bet.
Getting it right for the wrong reasons is perfectly legitimate in the investment world - the money is still money - and there is still the chance that the US market could power ahead in both local and foreign currency terms over the next couple of months.
Another strongly performing region has, of course, been Asia. The broader Japanese market is up by over 30 per cent so far this year (and the yen has been essentially flat against the euro).
Korea is up by around 35 per cent when measured locally, but up a whopping 56 per cent in terms of the euro. Hong Kong looks just like the US: broadly flat in local currency terms, but up over 17 per cent when adjusted back into euros.
Serious Money thinks that Asia should be the destination of choice for the euro-based investor - one with a healthy appetite for risk and decent growth prospects along with a chance of secular currency appreciation.
Currencies are once again playing havoc with returns. What is going on with the dollar? At first glance, it looks, once again, to be a story about relative US growth.
The gloom merchants have been confounded yet again and the US economy is growing at about three times the rate of some European economies. It must have a lot to do with interest rate policy.
The market understands that the Federal Reserve will raise rates until the inflation threat is extinguished. The market is also very confident that the Fed will manage this process well, with little chance of a major error.
By contrast, the foreign exchanges have not the faintest idea about the plans of the European Central Bank (ECB). Indeed, there is a growing suspicion that whatever the ECB does it will be wrong. Hence, confidence in the euro is once again ebbing.
Fund managers should be forgiven if they get their stock picking right but the currency decision wrong. The only people who seem to be able to get currencies right are very specialised traders sitting in hedge funds. Perhaps this is an argument for complete outsourcing of the hedging decision.
But in terms of the individual stocks, I am still willing to bet that the US could stage another surprise over the next few months.
Chis Johns is an investment strategist with Collins Stewart. All opinions are personal.
