Offshore currency exposure has lost its hedge edge for NZ investors, according to new research by recently-formed consultancy firm, Makao Investments.
The Makao study found the Kiwi dollar behaviour has changed significantly since the 2008 global financial crisis (GFC) as the NZ interest rate differential with US markets first flattened before sliding into inversion post 2016.
As also detailed in the biennial BNZ FX survey this January, with short-term interest rates now higher in the US than NZ, local investors miss out on the ‘carry trade’ kicker traditionally earned by exposure to hedged offshore assets.
But the Makao analysis says NZ dollar now appears to be both less volatile and not as sensitive to global equity moves as in the pre-GFC era.
The report says “the correlation between equity markets (MSCI world, in local currency) and the New Zealand dollar has indeed been impacted by the lack of the carry trade”.
“Our analysis suggests that the disappearing interest rate differential has had an effect on the New Zealand dollar and its risk characteristics,” the Makao study says. “The downside protection from foreign currency exposure might not be as significant as it has been in the past when the carry trade was on.”
John Horrell, who joined Makao founder (and former Russell Investments NZ colleague) Noah Schiltknecht in the business late last year, said last week’s 50 basis point drop in US rates has not fundamentally changed the trend.
“The interest rate differential (difference between the three-month cash rates) remains at similar levels today as the date we ran this analysis to (end Feb 2020),” Horrell said. “Regardless of how relative interest rates change in the near term, in our opinion, the interest rate differential has some way to go before the NZD reclaims it’s old carry trade status which reinforced it’s ‘risk on’ characteristics.
“We believe there is a relationship with this to the observed reduction of the downside protection qualities of foreign currency exposure to Kiwi investors.”
However, the Makao study says investors can’t rely on a “single correlation number” to forecast complex asset class relationships.
“… we have to consider how different states of markets impact the relationship between asset classes and currencies,” the report says. “We might move back into a state of stronger correlations again at some point in the future, in particular if we enter a severe market shock, or if the interest rate differential increases again.”
Schiltknecht launched Makao last August, targeting a gap in the small to medium NZ investment consultancy market.
He said in August investors including family office, charitable trusts, advisory firms and iwi were looking for “high quality advice but often cannot afford the fees that some of the current providers in the market charge.”
“The business will also do project work and offer tender consulting services to larger institutional investors,” Schiltknecht said at the time.
It is understood Makao has since picked up a several clients.