Should you ex­pect a change of for­tune for the euro?

How to profit from move­ments in the ster­ling-euro ex­change rate

Shares - - EXCHANGE-TRADED FUNDS -

There are many as­pects of Brexit that are yet to be fi­nalised, but one of the most se­ri­ous con­se­quences to date is the fall in the value of the pound. In the pe­riod since the ref­er­en­dum ster­ling is down by about 15% against the euro.

The pound is now only worth around 1.09 eu­ros and the last time it was lan­guish­ing at this level was in 2009 dur­ing the af­ter­math of the fi­nan­cial cri­sis. It is within touch­ing dis­tance of its all-time low of 1.03 that it hit at the end of 2008 when the Bank of Eng­land slashed in­ter­est rates to help sup­port the econ­omy af­ter the col­lapse of the banks.

Martin Arnold, di­rec­tor – global & FX strate­gist at ETF Se­cu­ri­ties, says that at the last meet­ing, ECB pol­i­cy­mak­ers ex­pressed con­cern ‘about the risk of the ex­change rate over­shoot­ing in the fu­ture’.

‘The euro has moved higher since and with the fu­tures mar­ket po­si­tion­ing at the high­est level on record, there are down­side risks for the euro against the pound.

‘The long EUR short GBP trade is over­crowded and the cur­rency pair could move back toward more his­tor­i­cally av­er­age lev­els around 1.11 with fur­ther down­side toward 1.17 in the com­ing year as clar­ity around Brexit ne­go­ti­a­tions is gleaned.’

CUR­RENCY ETFS

One way to take ad­van­tage of move­ments in the ex­change rate is to use a cur­rency ETF. If you think that the euro will con­tinue to strengthen there is ETFS Long EUR Short GBP (GBUR), whereas if you ex­pect the pound to re­cover you can use ETFS Short EUR Long GBP (URGB).

‘The ab­sence of lever­age (or trades on mar­gin) should mean that prod­ucts such as GBUR and URGB should be less volatile than cur­rency spread bets, CFDs or bi­nary bets and as such would be more suit­able for tak­ing a longert­erm view on a cur­rency pair,’ says Russ Mould, in­vest­ment di­rec­tor at AJ Bell.

GBUR and URGB are both in­tended to re­flect the per­for­mance of a po­si­tion in cur­rency for­ward con­tracts which are rolled on a daily ba­sis. This ex­po­sure is achieved via a de­riv­a­tive known as a swap that is pro­vided by Mor­gan Stan­ley & Co and that is backed by col­lat­eral to pro­tect against the coun­ter­party risk.

‘With this type of syn­thetic repli­ca­tion, the ETF provider en­ters into a col­lat­eral-backed

THE EURO HAS MOVED HIGHER SINCE AND WITH THE FU­TURES MAR­KET PO­SI­TION­ING AT THE HIGH­EST LEVEL ON RECORD, THERE ARE DOWN­SIDE RISKS FOR THE EURO AGAINST THE POUND

de­riv­a­tive agree­ment with a third-party bank. This method will in­cur trad­ing costs and cash pay­ments be­tween the prod­uct provider and the coun­ter­party,’ ex­plains Mould.

GBUR has an an­nual man­age­ment fee of 0.39% and over the two years to the end of July the in­dex that it tracks re­turned 23.6%, while the spot EUR/GBP ex­change rate rose by 25.9%.

Townsend Lans­ing, head of ETCs at ETF Se­cu­ri­ties, says that the re­turn of GBUR and URGB re­flects a to­tal re­turn on a fully funded cur­rency po­si­tion. ‘This com­prises: the spot re­turn from the in­dex pair, the dif­fer­en­tial be­tween the in­ter­est rates of the two cur­ren­cies, a col­lat­eral yield on the fund­ing to pur­chase the se­cu­rity, and the on­go­ing man­age­ment fee and swap costs.’

Be­fore you can trade th­ese se­cu­ri­ties you would need to fill in a com­plex in­stru­ments ap­pli­ca­tion form from your bro­ker.

EURO­PEAN EQ­UITY FUNDS

The 15% rise in the euro since Brexit has also helped the per­for­mance of Euro­pean eq­uity funds as it will have in­creased the value of their un­der­ly­ing port­fo­lios once trans­lated into ster­ling.

Ac­cord­ing to data from Morn­ingstar, the 299 funds in the sec­tor have risen by an av­er­age of 36% over the pe­riod from the Brexit ref­er­en­dum to 30 Au­gust 2017. The top three per­form­ers were Hen­der­son Euro­pean Smaller Com­pa­nies (GB0007476087A), Nep­tune Euro­pean Op­por­tu­ni­ties (GB00B8LF7310) and GAM

Mul­ti­stock Euroland Value

(LU1005066292) with gains of 65.05% to 61.61% re­spec­tively.

If the euro con­tin­ues to strengthen against the pound it would tend to fur­ther boost the per­for­mance of Euro­pean funds still fur­ther, al­though a sig­nif­i­cant re­ver­sal would prob­a­bly mean that in­vestors would have to give back some of their gains. Any­one con­cerned about this could re­duce their Euro­pean ex­po­sure or switch into a ster­ling hedged fund share class that hedges out the ex­change rate risk.

Dar­ius McDer­mott, man­ag­ing di­rec­tor of Chelsea Fi­nan­cial Ser­vices, rec­om­mends

Black­Rock Euro­pean Dy­namic (GB0000495209) an in­vest­ment fund which backs com­pa­nies of all shapes and sizes across Europe, as well as Black­Rock Con­ti­nen­tal Euro­pean In­come (GB00B3Y7MQ71), which pays an above-av­er­age yield with be­low-av­er­age vo­latil­ity. He also likes Thread­nee­dle Euro­pean Se­lect

(GB0001529345) which he says has de­liv­ered some of the strong­est re­turns in the sec­tor, while si­mul­ta­ne­ously be­ing one of the least volatile funds. All three have ster­ling hedged share classes for those that want them. (NS)

IF THE EURO CON­TIN­UES TO STRENGTHEN AGAINST THE POUND IT WOULD TEND TO BOOST THE PER­FOR­MANCE OF EURO­PEAN FUNDS STILL FUR­THER, AL­THOUGH A SIG­NIF­I­CANT RE­VER­SAL WOULD PROB­A­BLY MEAN THAT IN­VESTORS WOULD HAVE TO GIVE BACK SOME OF THEIR GAINS

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