According to FE Analytics, volatility as measured by the VIX Index – nicknamed Wall Street’s ‘fear Gauge’ – is currently up from its mid-year low by 43 per cent.
Performance of index since 4 July 2014
Source: FE Analytics
While a moderate correction in UK equities occurred in September and October, the FTSE All Share has been making back ground from its recent plunge and is currently just 2.31 per cent down on its pre-sell-off high.
Performance of index since 4 September 2014
Source: FE Analytics
However, according to David Jane, manager of the £535m CF Miton Special Situations fund, a ramping up of volatility in currency markets is putting investors’ future returns at risk if derived abroad.
“The environment is changing and is contributing to higher currency volatility. Our approach to currency exposure in our portfolios is to minimise their contribution to total risk, as currencies tend to be fairly speculative. As a result, in our portfolios we aim to have the majority of our exposure to sterling,” he said.
Sitting in the IMA Flexible Investment sector, Jane has a mandate to invest globally in funds, equities, fixed interest, cash and money market instruments.
However he says concern that returns may be eroded by currency volatility has led him to take out some currency hedges to protect returns that must be repatriated back to pounds in order to be returned to investors.
“Currently, we are hedging back some of our exposure to yen and euro assets, as we believe they have a bias to weaken in this environment, with central bank action pushing in that direction and their economics weak.”
“Our exposure to US assets is left unhedged, as economic growth is relatively strong and the US central bank is more advanced in its monetary path.”
Jane says heightened volatility within currency markets links to two themes that he has been playing in his multi-asset portfolios, which he calls the “new monetary regime” and the “new political regime”.
“The new monetary regime refers to the more active involvement of the authorities since the global financial crisis (GFC), as they have embarked on policies which openly manipulate asset prices. We thought that, with the major fixed income markets manipulated, currencies might act as an escape valve.”
“This hasn’t occurred to the extent that we thought it might have done but, in recent months, currency volatility has increased significantly and the dynamics driving currency markets have changed.”
He adds the macro environment points to further currency volatility.
“Our base case has been for low levels of economic growth but, within that, we expect growth to be uneven and so economies and monetary policies will continue to diverge. Even though we expect the authorities to continue to play a more active role than pre-GFC, policy objectives will likely be increasingly divergent,” the manager said.
“For example, the growing differential between US economic growth and the rest of the world has seen the US dollar strengthen, while the yen has weakened, mainly on the back of extra Bank of Japan action.”
“In addition, and this relates to the new political regime theme, a number of currencies have been hit by geo-political, and political, risk of late. For example, the Russian rouble and the Ukrainian hyrvnia have fallen sharply over recent months, on a combination of the conflict, the related sanctions and the lower oil price.
“The Brazilian real has also dropped significantly, on concerns that the re-election of the Workers’ Party’s Rouseff would be bad for the economy.”
Economists at Capital Economics say there have been three incidents in the past 20 years when the yen has rebounded substantially following a sustained period of depreciation, hurting returns repatriated to sterling.
“In each case, the trigger was an increase in financial market volatility. Yet while volatility is currently low by past standards, we suspect that any pick-up would not give Japan’s ailing currency as big a boost as it has in the past.”
The manager says the ‘new political regime’ theme refers to the idea there is no longer a single super power that is setting the global geo-political agenda. “As a result, geo-political events have been on the increase but, until recently, have had a fairly minimal impact on financial markets.”
Jane took over the helm of Miton Special Sits from former FE Alpha Manager Martin Gray in June.
Gray launched CF Miton Special Situations in December 1997. It was the best performing portfolio in the IMA Flexible Investment sector while Gray was manager, with returns of 289.51 per cent.
Since taking over Jane has returned 1.51 per cent compared to a sector average 2.25 per cent, although this represents a short period to evaluate performance.
Performance of fund and sector since 9 June 2014
Source: FE Analytics
The fund has an ongoing charges figure of 1.13 per cent.