In this piece, the Record team explore the phenomenon of the Natural or Neutral Real Interest Rate which can be thought of as the rate at which demand and supply are balanced and as the real return on capital.
For the rest of this article, click here.
Since the global financial crisis, the UK has suffered from "poor productivity". In this piece, Neil Record explores the details of this fall, what it means for the economy and which sectors are driving it.
To read the full paper, click here.
Developments in Greece and the Eurozone
With talks aimed at negotiating the terms of a €15 billion loan enabling Greece to repay the IMF breaking down, the Greek prime minister, Alexis Tsipras, has announced a referendum on the acceptance of the latest bailout terms.
For the full update, please click here.
Javier Corominas and Jonathan Scott recently contributed a chapter to a new book by Pojarliev and Levich on 'The Role of Currency in Institutional Portfolios'. The chapter discusses the economic rationale behind emerging market currency returns and the rewarded risk that investors can access by investing in them.
For more on this book, please click here.
The current trend amongst policitians in the UK is to bemoan the decline in the manufacturing sector. The aim of this note is to examine the potential of the services sector to drive UK growth in the future and to address some misunderstandings about the workings of modern economies.
To read the full paper, please click here.
Why the financial world is now almost impossible to understand
Neil focuses on the disconnect between the financial world and
the general public, which is caused by problems of language and
inadequate common discourse. Financial jargon has led to a
series of catastrophes (Neil highlights the recent example of a
Danish 'Dairy', who were missold a contract they scarcely
understood, and lost their entire deposit as a result) - and this
confusion extends to national governments. The key to avoiding
future disasters is to ensure that all financial language involved
in transactions (especially jargon and mathematics), are fully
You can read Neil's article here.
To achieve maximum returns consistent with an investor's appetite for risk, the correct identification and estimation of all relevant risk factors in a portfolio are necessary. This paper identifies the role of foreign currency as an important risk factor from an international investor's point of view.
Neil Record - Revised Essay - Wolfson Economics Prize
After the initial short-listing process, the five finalists for
the Wolfson Economics Prize were asked to re-write their essays
before the final round of judging. In this revised version, Neil
focuses on designing a route out of the Euro for one or more
countries which would minimize economic, financial and political
damage, whilst allowing growth and prosperity to replace crisis and
austerity. He continues to defend the position that as soon as one
country leaves the Euro, the view that the project is 'unbreakable'
would be indefensible, whilst analyzing the consequences of
piecemeal exits and the continuation of the slow-motion crisis,
with particular attention given to the Eurozone banking system.
Neil's full revised submission is available here.
Discussion: Implications for the Euro of the Greek
The June 17th election in Greece will represent a new milestone
in the two year-old Eurozone crisis. Record Currency Management
Chief Investment Officer Bob Noyen discusses the first implications
of the election results. This discussion was produced for an
investment audience and focuses on impacts on US investors' asset
portfolios. In particular, Bob focuses on the impacts on the Euro
both in the short- to medium-term and how the Greek result could
impact asset allocation and risk factors consultants face with
their clients. Euro equity assets represent approximately 20% of
most major indexes and the Euro is the largest single currency
exposure for most US institutional investors.
For a full recording of the discussion, click
Neil Record - Wolfson Economics Prize
In 2011, as the eurozone lurched from summit to summit,
caught in the throes of the sovereign debt crisis, Lord
Wolfson offered £250,000 to the architect of the most
elegant mechanism for the unwinding of the
eurozone. From the 425 entries received for the Wolfson
Economics Prize, a short-list of five finalists was chosen,
and announced Tuesday 3rd April 2012. Neil Record's submission was
one of the five short-listed entries. In the full paper, which can
be downloaded below, Neil outlines in some detail the steps
required in a number of areas if a transition from the currency
union were to be necessitated. It is Neil's firm view that if both
the turmoil of patchwork solutions and the catatstrophe of
unplanned default are to be avoided, the currency union must be
dissolved immediately and fully as soon as one member state's exit
becomes inevitable. Moreover, the transition is to be planned by a
secret, completely deniable task force led by Germany, whose threat
of walk-out and centrality as a player in the crisis would
hold the other nations together.
You can download Neil's full and fascinating entry directly
James Mackenzie Smith - Wolfson Economics Prize
In 2011 Lord Wolfson offered a prize of £250,000 for the most
elegant and imaginative suggestion for unwinding the euro zone. The
second largest prize after the Nobel in monetary terms, the
prize caused a clamour in eurosceptic circles and received 425
entries. Record Senior Research Strategist James Mackenzie Smith
submitted an entry for the prize, titled 'Plan B', which outlines
the legal, political and economic challenges in dismantling
the currency union. Whilst Neil Record, in his
submission, argues that the breakup would have to be planned
in secret, James disagrees and has written a paper which diverges
from Neils in several respects. Although not on the short-list
for the Wolfson Economics Prize, James' entry is a
high-quality piece of economic argument and makes an interesting
counter-point to Neil's piece.
James' entry can be downloaded directly here.
What Next for the Eurozone?
The recent dislocation in currency and credit
markets over the travails of the Eurozone has put concerns
regarding fiscal sustainability, current account imbalances, and
the economic recovery back to the forefront of investors' radar
screens. At Record we believe that these as yet unresolved issues
are critical and merit further attention and scrutiny. Indeed, what
had been termed theunthinkable is now thinkableand distinctly
We believe that the most recent sovereign debt
downgrades and the continued volatility in peripheral bond yields
are probably not the end of the story. It may have assuaged markets
temporarily, but this means that the worst case scenarios are
thusnot fully reflected in current asset price valuations. In
particular, we feel that there are particular outcomes that have
not yet been properly considered and that could drastically affect
the evolution of risk appetite, volatility, and asset class
returns. Furthermore, the impact of any of these outcomes could
come in the form of a sudden, unpredictable event, or 'black swan'.
The scenarios all point towards future paths that the Eurozone may
embark upon, either willingly or unwillingly, and which require
consideration for any investor.
Event Risk and Black Swans
Event Risk and Black Swans - what is in store for 2012?
This note outlines what Record's
research strategists perceive as the major themes and critical tail
risks to be monitored in 2012. While we do not expect all of these
risks to materialise over the course of the year, we believe
investors should pay heed to the portfolio and liquidity risks that
would be created by the scenarios below.
The Case for Emerging Market Currency Investment
As emerging market (EM) countries become richer their currencies
become stronger and in so doing their currencies converge with
those of developed countries. One of the most compelling arguments
for this is based on the convergence of EM per capita income
towards that of industrialised (OECD) countries. This is probably
best explained by the work of the economists Balassa and
According to the Balassa-Samuelson (B-S) effect the real
exchange rate (i.e. how many real goods does a particular currency
unit actually buy) is broadly a function of relative productivity
growth over the longer term. Countries that exhibit high
productivity growth are likely to have a tendency to see rising
domestic prices and thus an appreciating real exchange rate.
The Potential for Capital Controls in Switzerland
The Potential for Capital Controls in Switzerland
Switzerland's Finance Minister has said that Switzerland is
examining capital controls and/or negative interest rates as a way
of controlling capital inflows. This note looks at the
Assessing Sources of Excess Return in
This summary paper represents Record's view of the opportunities
to generate excess returns in currencies (November 2011). Currency
exposure is often viewed as a source of extra volatility which is
unrewarded in the sense that it generates no excess return over
In this paper we counter this view, arguing that the FX market
resembles other markets in that it contains opportunities which
persistently deliver excess returns. The existence of return
opportunities in the currency market (which is, by its nature, a
zero sum game) is justified by two facts: firstly, a large
proportion of market participants are not profit seekers; and
secondly, countries in external balance of payments deficit have to
make their currencies' prospective return sufficiently good to
attract currency investors.
The Euro - Consequences of a Break-up
A few short years ago, countenancing
the break up of the Euro was the preserve of sceptics, heretics and
the lunatic fringe, a position that has changed dramatically with
the unfolding of the Euro crisis. Not only is there now a
willingness to contemplate the possibility, but it has moved into
the mainstream of political, economic and financial debate. The
concerns Record has articulated since October 1998, before the Euro
came into being, are now playing out and this paper is a guide to
considering outcomes from an institutional perspective.
Specifically this paper considers institutional pension funds which
make up the core of Record's client base. These entities have
entered into hedging assignments strategically to match their
assets, i.e. international investments, to their future liability
stream which tends to be in a single currency typically where the
pension fund is domiciled.
International Investment Portfolios - Protecting Currency
This paper illustrates the Dollar weakness in a historical and
"fair value" context and the extent to which it has enhanced
foreign asset returns. It then outlines how a reversal would
affect these returns, and how hedging can mitigate this.
The Currency Forward Rate Bias as an Asset Class
Currency markets in the aggregate are necessarily
'zero sum' markets - i.e. an appreciation in the value of one
currency can only be expressed by reference to another currency,
which necessarily experiences a corresponding depreciation.
There is therefore no aggregate 'return' from simply holding
currencies, by contrast to equities, for example.
Notwithstanding this aggregate performance, there
are empirically-observable and persistent price patterns that
prevail in currency markets. The purpose of this paper is to
evaluate the proposal that one of these price patterns, the
'forward rate bias' (FRB), represents a rational 'risk premium',
i.e. payment of a reward for risk assumed in connection with an
The significance of the identification of the FRB,
or indeed any other price pattern, as a risk premium is that it
provides justification for long-term strategic investors, who seek
to allocate capital to rewarded risks, to regard that premium as an
asset class, and hence potentially worthy of long-term strategic
capital allocation, provided certain criteria are met. This
paper also considers what those additional criteria might be, and
evaluates whether the FRB meets them.
FX Transaction Costs - Plugging the Leakage in Returns
Custodian banks provide a service to their clients - to
safeguard their assets - and undertake ancillary transactions as
required. Some of these transactions require an accompanying
FX trade: this necessity has proved to be a hidden source of
revenue for custodians for at least a decade. Plan Sponsors
do not necessarily see custodians as requiring to be monitored on a
regular basis, nor do they typically consider the possibility of
transferring FX execution responsibility to an independent agent;
this paper argues that they should.
This document offers several suggestions including the
publication of time-stamps for each trade; a regular audit of FX
execution; and execution of FX by an independent agent. In short:
greater pricing transparency and/or elimination of conflicts of
interest is required.
The Euro - Greece in Context
The Eurozone is facing a serious crisis. This is not the
first challenge it has faced - there have been several in the
Euro's 11-year life, most notably the March 2005 softening of the
Growth and Stability pact to (in effect) sanction prior-year
breaches of the 3% deficit rule by France and Germany. But
none has yet gone to the heart of the Eurozone's constitution.
In the following pages, Neil Record revisits a paper he
wrote in October 1998 (published in early 1999), just before the
Euro came into being. He has annotated in the right hand
margin his observations on the scenarios in the paper, updated for
the conditions of the current crisis.
The Rationale for Currency Hedging
This note sets out some of the reasons why a UK institutional
investor might wish to hedge the currency exposure inherent in the
international components of its investment portfolio.
The Balassa-Samuelson Effect Explained
The most compelling argument for investing in emerging markets
relies on per capita income convergence towards that of
industrialised countries. This, the Balassa-Samuelson effect, is
examined in this paper.
Cash Flow Management in Currency Hedging Mandates
Cash Flow Management in Currency Gedging Mandates
This note considers various approaches to managing cash flows,
and in particular negative cash flows or cash outflows, for
institutional investors undertaking currency hedging of
international assets through forward contracts.
Disentangling Returns from Hedged International Equities
The purpose of this note is to describe the
various sources of return that accrue to a USD-based investor in
international equities, including any hedging returns. We
also comment on the importance of being able to distinguish between
these returns in reporting systems.