Rand not as cheap as current levels suggest

Denzil Burger, Portfolio Manager at MacroSolutions, a boutique of Old Mutual Investment Group.

Currency exchanges are notoriously difficult to forecast, with the ongoing ‘currency wars’ bringing increased turbulence. This is according to Denzil Burger, Portfolio Manager at MacroSolutions, a boutique of Old Mutual Investment Group, who believes that cheap currencies do not necessarily make good buys and the rand, at its current levels, may not actually be as cheap as it appears to be.

Burger and his team believe that the rand currently looks oversold, as indicated by the rand/dollar exchange rate compared to a measure of purchasing power parity between the US and South Africa. “It is dangerous to assume that because a currency appears cheap it will necessarily appreciate anytime soon. While the rand is not being managed to a specific level, there is a strong argument that it must remain cheap in order for South Africa to be competitive in a tough global environment.

“However, our balance of payments position has not really improved despite the expected benefit of a weaker currency – perhaps indicating a “less cheap” currency than is commonly believed,” he adds.

According to Burger the increase in allowable direct global exposure means that currency exposure has become less of a one-way orientation. “Exposure to the rand and other currencies in the portfolios we manage is a function of our view on prospects for exchange rates and currency risk management,” he explains.

“Our portfolios are positioned to reflect our fundamental view that the US dollar is likely to continue benefiting from a relatively healthy economy and hikes in interest rates commencing later in 2015. Prospects remain fairly muted for resource based shares as well as emerging market currencies in the current environment and going into 2016, although cyclical bounces are quite possible from relatively cheap levels.”

Having said that, Burger believes that there is a significant carry benefit from South African money market and bond investments that provides some underpin to the rand at current levels. “We hold a reasonable exposure to local bonds in our portfolios and are looking to reap the benefit of a more than 5% carry from local cash against essentially zero offered from offshore,” he says.

A challenge to currency forecasting, Burger points out, is that while many emerging economies have long used currency weakness as a tool to stimulate economic activity, developed economies have joined the “currency wars” in recent years. “Looking at the valuation of a currency in isolation as a guide to its future path would be increasingly dangerous in this environment. The Japanese yen has been weak (cheap) for years, but it is difficult to see it appreciating sharply with current policies in place, while the US dollar remained in the doldrums for several years before staging a strong recovery over the past year.”

Burger explains that while currency has become a more direct component of portfolio management for South African investors, as we have been allowed to increase offshore exposure over the years, it has always been an important factor. “For many years we were restricted from diversifying sufficiently from South Africa – and, as such, the rand – compared with what our own and other portfolio optimisation research indicated as appropriate levels of diversification. Further diversification was, and still is, achieved within the South African component of portfolios through, for instance, increased exposure to global players listed on the local stock market or other listed companies that benefit from a weaker rand.”