I am a firm believer in looking at potential investments from a global macroframework. Mutual funds tend to be esoterically divided into such strategies as “USMid-cap Value” or “Emerging Markets Microcap Growth”; it is my opinion that withsuch a restricted potential asset base, it can be extremely difficult for a portfoliomanager to be able to extract alpha. Global Macro is a broader framework, whichdivides investing into a three tiered analysis: firstly, the manager decides whichcurrencies are likely to outperform. Secondly, the manager decides what assetclass can offer the best return in the said currency zone. And finally, an instrumentis picked within the asset class decided. It is commonly said that “60% of the returnon an equity investment is based upon the performance of the market as a whole,30% is based on the performance of the industry, and only 10% on stock pickingability”. Global Macro is a means to extract alpha from not only the final 10%, butalso by analyzing the former two. Yet I do not see Global Macro and Classical Value Investing as necessarilyincongruent strategies. Indeed, given the historical outperformance of ValueInvesting, it appears likely to me that a successful manager could perhaps blend thetwo strategies into a broader framework. It is from this perspective that Iapproached this analysis.
It is often a difficult, some say impossible task, to predict currency fluctuations. Iagree while that attempting to guess short term fluctuations is often a fool’s game,the currency market has show some long term trends as well as historical dynamicswhich can be learned from.From a GBP perspective, I am very bearish on the USD, both in the medium and thelong term. In the medium term, it is likely that the recent surge in the value of theUSD is unsustainable. Due to the dollar’s role as the world’s reserve currency, US T-Bills are often seen as the world’s risk-free asset. Indeed, whenever a crisis hits(whether the 2008 crisis, the dot-com crash, or the Asian/LTCM financial crisis of 1997-98) investors throughout the world drop their risky assets and pile intoEurodollars. This dynamic is well known. Yet as the world reaches the light at theend of the proverbial tunnel, investors are likely to sell their Eurodollar holdings andstart investing again in risky assets. This will undoubtedly cause the value of theDollar to decline in the medium term.While I am also bearish on the USD in the long term, I am not as confidant aboutthis projection. In my estimation, the long term downward trend in the USD couldbe due to one of two reasons – what I call the “capital flows approach” versus the“financial innovation approach”. If the first hypothesis is correct, the dollar’s role asthe world’s reserve currency has built up massive macroeconomic imbalances whichare being slowly alleviated ever since the fall of the BrettonWoods scheme. In other