Currencies are an asset class which tends to be volatile, and one which our funds are exposed to, as they’re global multi asset funds. We look to ensure that currency risk doesn’t dominate our portfolio risk, by hedging some of the overseas currency back into sterling. 
This level of currency risk is concerned with the ‘translation effect’ into sterling, on the value of investments overseas through their currencies, but there is another level of currency risk which is more difficult to mitigate against. This is because one of the underlying drivers of asset class performance is often currencies, particularly the US dollar, which remains the dominant currency globally.
For example, a weak US dollar tends to favour emerging markets, because much of their debt is US dollar dominated, and so the debt falls in value in local currency (assuming the US dollar is weak against emerging market currencies). In addition, many emerging economies are commodity heavy.
In contrast, a strong US dollar can help those developed economies which are export heavy, such as Japan or the eurozone, as it tends to make their exports cheaper (assuming a strong US dollar translates into a weak yen and weak euro).
Performance of euro & sterling vs US dollar over 1yr
Source: FE Analytics
We always try to look at risk in a holistic way, rather than being model-driven, and so we’re mindful of how these two levels of currency risk interrelate. Taking Japan as an example, we might think that hedging back the yen exposure of our Japanese equities into sterling would reduce our risk, but it can actually do the reverse.
A weak yen benefits both the hedge and the export orientated equity market, whereas a strong yen hurts both, and so a full hedge makes our performance more directional and, arguably, adds to risk. There are options of course, we can part hedge, or we can buy Japanese equities that have a domestic bias.The US dollar retains its crown and, as such, its impact on regional asset allocation and commodities. We rarely take strong views on currencies, so currency moves for us tend to be another tick in the box, rather than a primary driver of a view.
As an illustration, we have liked emerging markets because we like risk assets, because global growth is strong and rates are low, and the weak US dollar has been a good tailwind too.
The US dollar impacts many things and, in turn, many things influence the US dollar, with factors such as politics, economics and the Federal Reserve all complex, interrelated and difficult to second guess. As a result, we refrain from forecasting and instead look for changes in patterns and potential triggers for change.
At the beginning of the year, the consensus on the US dollar was for it to strengthen and, now, after it’s spent most of that time weakening, the consensus is for it to weaken. Also the European Central Bank has made noises about too much euro strength recently. Should we expect central banks to start to be more interventionist on currencies again, after a period where they have refrained?
In terms of triggers, sustained US wage pressures, for example, would likely challenge the US dollar trend for weakness. Currently, there is little evidence of wage pressures at a top down macro level, and there hasn’t been for the entirety of this expansion, but bottom up newsflow is starting to contradict this.
As ever with financial assets, but especially currencies, there are numerous cross-currents and key US dollar sensitive events are likely to be the Fed balance sheet reduction programme and the US debt ceiling.
Looking at our current exposure, we have a large part of our overseas currency hedged back into sterling, while our regional asset allocation is fairly diversified, i.e. in aggregate not positioned to benefit from a specific US dollar direction. These exposures combined reflect our lack of strong currency views currently, which sits well with our preference for focusing on outcomes, not views.
Anthony Rayner is manager of Miton’s multi-asset fund range. All views are his own and should not be taken as investment advice.