The goal of this investment process is to develop an internally consistent forecast for all of the main components of each economy and particularly government monetary and fiscal policy, economic growth and inflation. This leads to a forecast for the level and likely trend in short and long term interest rates and for the likely direction of currency movements with respect to all other major economies. For each country, the interest rate and currency forecast is framed within an expected time horizon and is given an associated degree of certainty.
There is an intriguing parallel between analysing a country and analysing a company. A country's "balance sheet" is made up of net debt, national savings, reserves and the quality and efficiency of the national infrastructure. The "income statement" is made up of GDP and the current account and the "share price" is the currency value.
Confidence in the macroeconomic forecast is important because (1) interest rate cycle risk management presupposes the need to identify prospective movements correctly and (2) there is a need to know when the "fundamentals" are sufficiently mixed or confused that no investment position should be taken. The risk is not only whether the forecast is correct but also whether the case for making any investment is sufficiently strong and consistent.
Uncertainty in the forecast may well be due to expected interest rate volatility; a component of interest rate cycle risk which needs to be controlled. Historic market data reveals that some countries consistently display an above average level of interest rate volatility. The causes of this may be systemic or ephemeral, but, to the extent that the volatility is created temporarily by political or economic instability, the investment process seeks to identify and anticipate this risk and to ensure that it does not appear unexpectedly and damage portfolio returns.
Country by country, the analysis looks at each real economy and its natural non-inflationary growth potential - which is defined by demographics, capacity utilisation rates and the cost and availability of capital. The characteristics of current GDP growth, (such as industrial production, the trade account, capacity utilisation and wages) are also analysed in order to form an outlook for growth over the near term (3-6 months) and longer term (1-2 years). Government policies play a significant role in shaping this economic growth; as a result, monetary and fiscal policies are carefully monitored for consistency and effectiveness. When these policies fail, the result is usually inflation - and then recession.
The outlook for inflation is of particular importance. Inflation analysis covers not only the components of reported inflation, but also the inflation rates of asset prices given their importance in the financial system.
From time to time the range of eligible markets is confined by the manager to a smaller group such as G7, if the perceived risk associated with other markets is too high.
To the extent available in each bond market, the full range of debt maturities and coupons is utilised so as to include the longest dated maturities and zero coupon bonds whenever considered appropriate and prudent by the manager.
If approved by the client, the manager will also invest in interest rate and foreign exchange futures and options contracts in order to implement strategies more efficiently and cheaply - as well as to enter into strategies which cannot be played out with conventional bonds.
Bond market selection and currency risk management are active processes which create conservative, low risk, diversified portfolios, meeting the primary goal of the bond owner.
In the event of the client wishing to change existing banking arrangements, Culross is able to introduce a choice of first class global custodians.
Tel: (44)-171 409 1352
Fax: (44)-171 409 2514
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