When I began managing multi-asset investments in 1990, I believed fundamental valuation was the way to create superior performance. Today, I believe that fundamental valuation is necessary, but no longer sufficient. We have to navigate the path that prices take on their way to fundamental value.
That involves assessing shorter-term macro and geopolitical developments that push prices toward and away from fundamental value. This can be difficult because when big events happen, markets may move together. That is one of the reasons why we utilize fundamental-based currency management to a large extent.
We believe the best way to get macro diversification in our portfolios is to utilize active currency management to a large extent.
First, currencies tend to be uncorrelated with other assets over time, which means they can be a powerful diversifier.
Investing in currencies also adds a tool to our toolbox in our navigation of geopolitical developments, such as Brexit, because those developments often have a first effect on exchange rates. They push exchange rates either toward or away from their equilibrium exchange rate—fundamental value—as they get resolved.
In addition, the differentiated central bank policies and behaviors around the world influence currencies. We’ve seen quantitative easing not just in the United States, but now occurring across the world, and it’s affecting exchange rates.
Lastly, our research and experience demonstrates that prices converge on fundamental value for currencies faster than for equities and for bonds. That means that fundamental value can be a very powerful influence for currency management. This shorter reversion horizon provides the opportunity to more quickly exploit value/price discrepancies for currencies than for markets.
For these reasons, we believe the best way to get macro diversification in our portfolios is to utilize active currency management to a large extent.
Still, we also have to assess the impact of macro events on market prices. Inflation has the biggest influence on fixed income assets, so these geopolitical developments have recently had a relatively small impact on fixed income.
But equity prices are very susceptible to market events (such as geopolitical developments and central bank activity) because these events can ultimately change corporate cash flows.That, in turn, affects how efficiently a company is able to produce and export.