USD / Debt / Gate Keepers

Moody’s Investors Services came out yesterday saying the US and UK have moved substantially closer to losing their AAA credit ratings. The announcement was the primary focus of the business news services to kick off the new week. Looking at the currencies moves overnight the markets seemed to have just yawned.

The historic trading relationships amongst the basket of currencies based on the perception of defensiveness and risk appetite appears to have been largely maintained over the past eighteen months. We think is an interesting dynamic given both the level of debt funded government support that has been injected into the developed world and also given how central the focus of sovereign risk has become amongst the investment community.

We take an active interest in currencies and sovereign risk, we have tried to take a fundamental approach to this research function. The questions we are focused on are how much debt do they have, what is their ability to service this debt, how has their debt position moved over time and what are the demographics issues that are likely to impact their position moving forward. Surprisingly the information is readily available, it is easy to track down and generally there is a tremendous amount of history and granularity to it. The difficult part though is converting this effort into profitable investments. There are numerous examples over the past eighteen months similar to last night when we have thought this is some sort of confirmation, but the markets have begged to differ.

The work we have done in this regard will come through the fund in two ways:

• From time to time we will look to buy currency options with the objective of profiting from the historic trading relationships breaking down due to a fundamental deterioration in the sovereign risk position of a country. We regard this as a capital preservation strategy within the fund. 
• We are trying to buy businesses that have a desirable offering regardless of the medium of exchange. Effectively, if the franchise is strong enough we suspect this is the best longer term protection we can get.

Bloomberg Article – Moody’s Says …