Currency as an asset can be risky

Some things never cease to amaze me. One is that foreign exchange (FX) can be viewed as an asset class, as some types of literature would have you believe.

It is one thing to trade cash for gold, a metal of limited use, but which has a psychological cachet as a form of wealth.

A decent argument can be made that in a dangerous world, politically and financially, gold should play a part in a diversified portfolio.

But it is quite another thing to imagine that taking a position in a currency other than that in which you base your everyday affairs is anything but seriously risky. (Expatriates choosing the timing of their remittances home is another matter.)

The FX market is colossally liquid, deep and global, with its trading participants massively motivated to squeeze out every drop of relevant information.

So any assessment of an exchange rate's likely direction has to overcome the wall of prior knowledge already out there (whereby supply and demand have procured a balance) — and therefore effectively faces the toss of a coin as to what happens next.

Beyond that intimidating fact, currencies are known historically to overshoot compared to fundamental measures of their value. At any given moment, whatever rationale has been determined in the market's overall ‘group-think' won't have much to do with underlying worth. It's rather a matter of the mood music that's playing at the time.

Further still, not only does the tune in the market's head have a habit of switching as if on a jukebox, but economic statistics, as partial drivers of FX movements, can be interpreted in different ways, so a lot depends on which source of sentiment will hold sway.

Besides all of which, we have experienced an era of financial crisis wherein previous understandings have gone out of the window. The advent of the ‘risk-on/risk-off' motif to fragile world markets has served only to underline how doubtful an exercise is picking winners.

Most obviously, the US dollar, which has spent years shrugging off the attribution of chronic decline, has benefited as a supposed safe haven on days when collective panic has set in, but then been dumped when the economic clouds appear to lift for a while.

It's a dichotomy only reinforced in its impression by the gyrations of the euro, the dollar's key trading counterpart, which still appears relatively strong despite the Eurozone's acute weaknesses.

Those are undoubtedly concerns for Gulf investors — with domestic currencies pegged to the dollar — who are often exposed already to overseas investments, i.e. in other denominations.

Zero-sum game

Compared to the ups and downs of stocks, FX seems like a zero-sum game, and you don't have to believe in the efficient markets hypothesis to feel that you would have to be lucky to outwit the market on any consistent basis.

Speaking candidly, wealth managers will actually say much the same.

Asked whether FX can seriously be considered an investment, Sumeet Bhambri, General Manager, Wealth Management for the Middle East, Standard Chartered Bank, replied, "there is no right or wrong answer to this question," but continued, "though there is a lot of interest in taking [such] exposure, it is difficult to categorise FX as an asset class, primarily owing to the lack of an appropriate benchmark and of a real asset underlying".

Gary Dugan, Chief Investment Officer, Private Banking, Emirates NBD characterises FX as a factor in investment, albeit an important one, rather than an investment itself.

"Currency cannot be considered an asset class," he says. "However, it is an important element of asset allocation [as] swings in currencies can enhance or decimate returns."

However, Matthew Waterfield, General Manager Middle East and Africa, Friends Provident International, takes a quite different stance.

"I would argue that — as the FX market moves independently of other asset classes — it should most certainly be considered an asset class in its own right." He emphasises that the low correlation element enables diversification.

Clearly, there's very much a debate still to be had.

Gulf trends: Greater risk aversion

If foreign exchange has its drawbacks (and costs if a fund manager is employed), could it be that those whose fingers were burned in stocks have been driven to riskier alternatives?

In fact, the reverse is reported. Recent surveys cite greater risk aversion these days among Gulf investors. Invesco Perpetual's latest such research observed, even so, that short-term returns remain a priority. As Nick Tolchard, its Middle East head, says, that appears contradictory. Long-term safety and volatility don't mix.

Similar studies by Friends Provident International show that investors' horizons are now lengthening, while cash and gold remain preferred.

Standard Chartered's Bhambri notes the deference still to real estate, and that alternative investments are used by investors looking further into the future. Investing "culture in the GCC is based on something we can touch and feel," he says.

— A.S.