It’s one of the biggest dilemmas facing currency managers: how to protect against the fallout from the UK leaving the European Union without losing money should it vote to remain.
With the pound’s volatility against the dollar at the highest in six years and options on its most traded currency pair the most expensive on record, traders are looking for other solutions in the run-up to the June 23 vote.
For some investors, including Unigestion SA and Aberdeen Asset Management, that means buying options on the Swiss franc and Swedish krona or using the euro as a proxy for sterling.
“Brexit risks are underestimated,” said Luca Simoncelli, a London-based money manager at Unigestion, which oversees $19.5bn. “The event would be similarly damaging for both the euro and the pound and this is why we bought put options on the euro against the Swiss franc.”
To benefit from a possible relief rally, Unigestion also purchased call options on the pound against the Swedish krona. The put options benefit from the euro falling versus the Swiss currency. Investors should watch the franc to gauge the risk of Britain leaving the EU, David Bloom, head of global currency strategy at HSBC Holdings Plc in London, said in an interview on Bloomberg Television’s “On the Move” with Guy Johnson yesterday.
The pound has been a barometer of sentiment during the referendum campaign, falling to a seven-year low after the vote was announced in February before climbing in recent weeks as polls pointed to a higher chance of Britain remaining in the EU.
With the currency still reacting to even minor shifts in public opinion, and four weeks of a volatile campaign left to go, investors need to guard against the possibility of both outcomes.
To read about how ordinary Brits are dealing with the currency implications of the referendum, click here.
For James Athey, a money manager at Aberdeen, which manages $420.9bn, the euro is the best proxy currency to trade referendum risk.
Athey expects the shared currency to weaken by around half as much as the pound if the UK votes to leave the EU, translating to a potential 5% to 15% euro decline. If Britons vote to remain, the Federal Reserve’s monetary policy will become the main driver for the euro, he said. Aberdeen is currently betting the 19-nation currency will fall against the dollar.
“We do not feel the risk-reward is attractive here to play sterling from either side,” London-based Athey said. “The better opportunities may emerge after the vote itself.”The pound was at $1.4649 in London yesterday. That left down 0.6% this year, after being down as much as 6.1% in February.
Despite the recovery, investors are braced for volatility around the referendum. Implied one-month volatility for the pound against the dollar closed at 16.41% on Thursday, the highest since the aftermath of the UK election in 2010 and exceeding the two- and three-month measures in a sign of heightened concern.
Options that guard against future losses are the most expensive on record. The premium for one-month contracts hedging against sterling declines compared with those protecting against gains widened to 5.59 percentage points yesterday, the most based on closing prices since Bloomberg began compiling the risk-reversals data in 2003.
Money managers are also looking to other asset classes to hedge their risks. Just one of three trades recommended by Pacific Investment Management Co’s Mike Amey to shield against referendum volatility involves sterling, with the other two based on buying UK bank and sovereign bonds.
Pimco, which manages $1.5tn, estimates there’s a 40% chance of Britain leaving the EU.
“Portfolios can be structured to potentially benefit in the event that the UK remains in the EU and hedged in the event it takes the alternate path,” London-based Amey said.