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OPINION

Going back in time

Going back in time
October 18, 2016
Going back in time

After the usual stuff about blaming market speculators, Mr Wilson noted that "the pound abroad is worth 14 per cent or so less in terms of other currencies". Then, keeping a straight face, he delivered that immortal line: "That does not mean, of course, that the pound here in Britain - in your pocket or purse or bank - has been devalued." No, Harold, of course not. Real devaluation only hits when the currency drops 20 per cent in next to no time, as it has just done.

But nowadays, what with floating exchange rates, the prime minister is no longer compelled to butt in to peak-time viewing to tell us we're all poorer, with a performance that must be homely, powerful and sincere yet will be parodied as weak, shifty and self-serving. Pity.

Nearly 50 years on - and from an age when politicians were still media ingénues - I reckon Mr Wilson was ahead of his time, even if he sounds as if he's auditioning for Captain Mainwaring's role in Dad's Army, to be launched onto the little screen the following year.

Don't take my word for it. Check out his performance on You Tube, but not before you have considered the effect of sterling's present - and quite possibly - future devaluation on your portfolio.

Today's concern is that sterling looks like a one-way bet. If I were a currency trader I'd be testing to see just how far the Bank of England is willing to let the currency sink. Clearly the Bank has a dilemma. True, there is some advantage to exports - although less than many punters imagine - in the pound's weakness. Yet if the pound falls far enough, then from out of the black lagoon may slither that creature we thought had perished with the demise of the dollar standard - a sterling crisis.

It's not completely fanciful. To a worrying degree, Britain depends on the kindness of strangers, those foreigners willing to buy sterling assets to plug a trade deficit that runs at 5.6 per cent of national output. That's a proportion of output no other developed nation can match; Australia comes closest with a gap of 4.2 per cent. Yet the inclination of foreigners to keep adding to their sterling exposure will be tested as sterling buys less and less in their domestic currency, offers next-to-no interest by way of compensation and shows no sign of being bolstered by the Bank.

So a portfolio needs insurance against the worst. Happily, equities offer natural hedging. After all, almost every equity portfolio will have holdings in companies that generate revenue in currencies other than sterling. Thus in May, anticipating sterling's likely weakness in the event of a Brexit vote, the Bearbull Income Portfolio added a holding in speciality chemicals supplier Elementis (ELM), which generates 95 per cent of its revenue overseas. Similarly, it's no coincidence that the fund's holding in Vesuvius (VSVS) has been strong since June's vote - the supplier of consumables for foundries has the same proportion of overseas business.

Portfolio insurance can be more specific than relying on companies' overseas activities. The table indicates which of seven broad asset categories - all of which are priced in US dollars - can offer the best hedging. Of course, 'can offer' does not mean they will. The data are for correlation co-efficients, whose range is from plus 1.0 to minus 1.0 where the lower the number, the better. The values are based on monthly returns over the past five years. So they may not offer an accurate impression of the future, but they are probably as good as any other guess.

 

A correlation matrix - which protects your portfolio best?
 Bearbull IncomeAll-ShareCoffeeCopperCornCrude oil£/$ rateGoldSoybean
Bearbull Income1.00
All-Share0.481.00
Coffee0.110.251.00
Copper0.100.420.111.00
Corn0.060.130.060.031.00
Crude oil0.150.360.180.460.131.00
£/$ rate0.360.130.030.230.260.341.00
Gold0.030.190.260.35-0.010.15-0.121.00
Soybean0.000.140.070.180.670.280.20-0.021.00

Source: Capital IQ

 

They indicate it's probably not worthwhile for the Bearbull income portfolio to do any specific hedging against the dollar. Interestingly, that finding does not apply to the FTSE All-Share index where hedging with exposure to copper and crude oil isn't worth the bother.

Of course, it's pointless selecting an asset as a hedging instrument if you think its price will fall steadily. For the Bearbull portfolio, that might exclude gold from the reckoning. That might be a pity because gold's negative correlation with soybean makes the two of them a great hedging combination. True, the exercise may be academic because my portfolio does not have spare cash, but it's worthwhile applying to every equity portfolio.