The reserve-currency argument

Anyone who doubts this only has to look at the US dollar's performance since the onset of the credit crunch. Despite all the shortcomings of the US economy, which were both cause and effect of the crunch and its aftermath, demand to hold greenbacks has remained strong thanks to its safe-haven status.

Simultaneously, however, investors aren't blind to those shortcomings - too much debt, too little growth, paralysis of the political process and so on. Hence the working hypothesis - I probably can't put it stronger than that - that the dollar's tenure as the world's reserve currency is approaching its end when it will be replaced by the Chinese renminbi.

I am sufficiently persuaded by the arguments in favour of the renminbi to put 15 per cent of the global fund's capital into it. I've done this via an exchange traded currency (an exchange traded fund, really) - namely, ETFS Long CNY short USD (code: LCNP). The title is a mouthful, but this instrument, which is listed on the London Stock Exchange and is eligible for individual savings accounts, tracks a total-return index that mimics a long position in the renminbi and a short position in the dollar.

It's not the ideal way to gain exposure. The index being tracked has a history of lagging the spot-rate movements between the dollar and renminbi. The short exposure to the dollar is a complication, too. But I can rationalise it like this: I don't really want any exposure to the dollar but I am long of it via the fund’s holdings in ETFX Global Agri Business and ETFS Cocoa, both of which are priced in dollars, so this short position helps to balance those out. Second, I can reasonably assume that in the long run the dollar and sterling will decline at roughly the same pace against the renminbi, so it should not matter that the dollar is in this particular mix rather than sterling. Last, this fund is a so-called ‘synthetic’ one. This means it has no underlying holdings of renminbi. Instead, it relies on a counterparty to supply any gains it makes. To a large extent, therefore, the fund is as good as the collateral it posts and its counterparty's ability to fulfil its obligations. Despite these shortcomings, this fund will have to do because the best solution – buying renminbi directly – isn't available, at least not yet.

The renminbi exposure has arrived by way of cutting in half the fund's exposure to oil – via ETFS Brent 1 month – and to the Norwegian krone. Now that fear of an 'Iran event' has receded, the weakness in demand for oil is driving its price. That factor is also behind the decision to lighten the krone exposure. Norway's economy hardly relies on oil in the way that, say, Russia's does, but the correlation between movements in the oil price and the krone exchange rate are too firm to ignore.

This leaves me with two pressing tasks. The first is to decide what to do with the fund's exposure to cocoa. This commodity went into the fund on the strength of its record as a hedge against equity-market risk. Put more formally, the historical correlation between moves in equity markets and cocoa prices is poor – a good thing if you want to reduce a fund's volatility. In the past 18 months this pattern has reversed and cocoa, in effect, has been a high-beta play on falling equity markets - yeuk. What the cocoa price may proceed to do, I don't know. But I should formulate a view.

Second, it would be really nice - though I don't expect it to happen - if I could find a practical way of short selling government bonds of developed economies. This is partly because the 20-year bull market in bonds is approaching its end and all sorts of arguments point to the next secular shift in bond prices being downwards. In addition, if I could go short of government bonds then, in effect, I could borrow at the risk-free rate of interest. And that would foster all manner of ways to enhance the fund's returns while reducing their volatility. But can I borrow at the risk-free rate? Dream on.