beyondbrics

By Robert Cookson and Henny Sender

Here’s something for investors who want the potential of emerging market stocks and bonds but are afraid of the currency exposure.

FTSE, the index group, has launched a basket of eleven currencies and two commodities – gold and oil – designed to protect investors against currency and inflation risk. While it is not EM-specific, it could be useful to investors in EMs as it includes the currencies of the four Brics.

Called the “wealth preservation unit”, the basket will allow investors to hedge their currency exposures into an international, diversified unit of account and thereby preserve the global value of their investments.

“This tells us about the world we live in,” said Sacha Tihanyi, currency strategist at Scotia Capital. “It’s in the spirit of the times, the macro-financial zeitgeist you could say. It’s all about protecting against currency debasement.”

The world’s central banks have created an unprecedented amount of base money in recent years through loan programmes and and asset purchases, known as “quantitative easing” or “money printing”. This month, the Bank of Japan announced an additional Y10tn of asset purchases while the Bank of England authorised further gilts purchases of £50bn.

Ronald Liesching, chairman of Mountain Pacific Group, who developed the basket with FTSE, said it would provide a hedge against future inflation as loose monetary policy and fiscal deficits in the developed markets erode the real value of currencies including the dollar, euro, sterling and yen.

“If you are a global equity investor, it is likely that 80 per cent of your investments are in markets where the currency will lose value,” he says.

The FTSE wealth preservation unit, or WPU, is made up of the world’s largest seven currencies, the currencies of Brazil, Russia, India and China, and a small weight in gold and oil.

The US dollar has the biggest weight in the basket, at 23.3 per cent. The Bric currencies have the smallest weight, with the Russian rouble at just 1.8 per cent.

Gold and oil account for 3 per cent and 1.5 per cent of the basket, respectively. FTSE said that this commodity exposure “does not aim to make money: it simply aims to offset the long term erosion in the value of paper monies.”

While the WPU basket is not yet tradeable, Reza Ghassemieh, head of research at FTSE, said several large financial institutions plan to create products based on the basket, including currency overlays, swaps and exchange-traded funds.

Ghassemieh added that institutional investors, sovereign wealth funds, and private family offices had all expressed interest in the hedging tool, which was developed with Mountain Pacific Group, an investment management company.

However, analysts said the basket could face difficulty gaining traction in the market.

Few currency baskets have proved popular in the past, since investors are accustomed to hedging their currency exposures on their own terms, according to their own weightings.

The SDR, or special drawing right, is a fixed basket of four major currencies designed in 1969 by the International Monetary Fund to replace gold as the international unit of account. It has been little used by institutions other than governments.

The USDX, or dollar index, which trades on IntercontinentalExchange (ICE), has proved more popular. Created in 1973, soon after the collapse of the Bretton Woods system, the USDX is a basket of six major currencies that does not include the US dollar.

Related reading
The inflation versus deflation riddle, Tony Jackson, FT
Hedgehopper’s guide to living with inflation, John Authers, FT