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Sterling bottoming out - so look elsewhere

Tuesday 29th June 2010
Following a torrid three years, sterling is at last beginning to bottom out, according to Rob Pemberton, investment director of wealth manager HFM Columbus.

"In a tough year for investors one bright spot is that the weakness of the pound has meant that overseas assets have seen healthy currency gains when translated back into sterling," he said.

"So, while the S&P500 index and the Japanese Topix Index have both fallen 3% in local currency terms so far this year (to 24 June), Topix has gained 10% and the S&P500 5%, when translated back into sterling - and this has been reflected by positive returns from North American and Japanese equity funds."

For investors wishing to maintain overseas market exposure without currency risk, the best option is to buy sterling hedged share classes.

Sterling’s falls against other currencies - 22% against the Euro, 34% against the US dollar and a massive 80% against the Yen – have had a "hugely significant effect on investment returns", he said.

"Over the last three years (to June 24) the FTSE100 has fallen by 12% and the S&P 500 index by 25%. However, due to the weakness of sterling the average UK All Companies equity fund has fallen by 15%, whereas the average North American fund has actually produced a flat return. The effect is similar for most other global (ie non-UK) funds.”

Pemberton predicts however that the decline of sterling may now be coming to an end.

"If this proves to be the case, this will have negative implications for holders of UK registered funds invested in overseas markets, given that these funds are virtually all un-hedged, such that the their return is a combination of the market return and the gain or loss of the local currency against sterling."

For investors who wish to buy overseas funds but through a sterling hedged share class (so there is no currency gain or loss) Pemberton recommends the GLG Japan Core Alpha and Martin Currie North American funds.

"Both have sterling hedged share classes for retail investors, and the newly launched Ignis Argonaut European Enhanced Income fund has a sterling hedged share class specifically targeted at income seeking investors who want diversification away from the concentrated and frequently similar portfolios of UK Equity Income Funds while not having to take any currency risk," he said.

So why has sterling has been so weak in recent years?

"Our budget deficit position is among the very worst, the UK economy continues to show minimal recovery and interest rates remain super low. In addition sterling had until a few years ago become significantly overvalued against other major currencies, principally the US dollar, against which it scaled a 25-year high in 2007," he said.

"The dollar is sitting pretty at the moment as the world‘s largest economy and the global reserve currency. It is a perceived safe haven in a very scary world. The US economy is recovering better than the UK and Europe and the greenback has been flying.

"However, the purchasing power parity valuation of sterling against the US dollar is generally held to be around 1.60 so sterling has slipped to a significant undervaluation," said Pemberton.

"The UK’s problems are well documented and understood by financial markets and being short of the pound is somewhat of a 'crowded trade'. It now looks like all the bad news is 'in the price'. I think the Budget sent a strong signal to financial markets that the new government means business in cutting the deficit. Sterling has been resilient over the last few weeks, arguably signalling that a bottom has been reached."

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Mike Jones

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