By JASON HOLLANDS
Attention has shifted significantly in recent weeks to the eurozone, which has been staring down the barrel for some time at a toxic combination of anaemic growth, withering levels of inflation and credit contraction as a result of the failure of its banking sector to recapitalise to anything like the extent the US banking sector has. All of this has helped fuel mounting expectations of eurozone "QE", hitherto resisted by the Germans.
The intensity of this focus has accelerated materially of late as a result of two key developments: firstly, the prospect of anti-austerity parties prevailing in Greece's snap elections, which has raised the spectre of a possible Greek exit from the eurozone and, secondly, the news that the eurozone been plunged into deflation this week. The latter has been exacerbated by the collapse in the oil and gas prices, which while undoubtedly bad for the inflation figures, does have a positive impact as well for Western Europe, which is a major net importer of energy.
For some time we have been arguing that investors should shift their European equity exposure into funds which mitigate the currency risk by hedging their euro exposure back into Sterling. Indeed we reflected this in our own managed funds - our multi-asset portfolios - some months ago.
While full-blown QE should be supportive for European equity markets (and other risk assets), as it has proven to be the case with stimulus programmes elsewhere such as the US and Japan, we also know that vast money printing programmes lead to relative currency weakening. With the US now in a post-QE environment and with expectations of rate rises in the US and UK this year (with the US likely to move first), a real disparity is potentially opening up in 2015 between those central banks walking the road to "normalisation" (albeit carefully) and the likes of the Bank of Japan (who have slammed the accelerator down) and the ECB who are expected to switch on the printing presses in earnest. For this reason, many asset allocators are minded to follow the flow of new cash, rather than countries with more robust economic fundamentals.
Already the euro has tumbled to a nine-year low versus the dollar and while it is difficult to know where the floor is, the balance of probability is stacked against the euro compared to the dollar and, maybe, the pound. Therefore for risk-reasons, it makes sense for sterling-based investors to hedge their exposure to the euro back into sterling.
This is a strategy that has certainly worked well in Japan over the last two years of massive national balance sheet expansion. For example, while the popular GLG Japan Core Alpha Retail fund has delivered a handsome 32per cent total return over this period, the currency hedged version (GLG Japan CoreAlpha Equity I H GBP) which we have been highlighting for some time generated a comparable return of more than twice that (73per cent).
The dilemma for UK investors is that whereas a number of fund managers offer currency- hedged Japanese funds, the fund management industry has been slower off the mark in offering such versions of their European equity funds. Two we like are the Artemis European Opportunities Hedged fund and the JPM Europe Dynamic ex UK C GBP Hedged fund. Investment in currency-hedged European equity funds has already yielded significant return premiums over the traditional versions, in the case of the Artemis European Opportunities fund a one year return 1per cent on the traditional fund has been trumped by 7per cent on the currency-hedged version.
Jason Hollands is managing director at Tilney Bestinvest
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