Invesco Canada blog

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Matt Peden | July 2, 2015

Greece, the euro and Trimark’s positioning

The current situation in Greece and the recurring problems in the eurozone since the global financial crisis stem from flaws in the currency union’s structure, which while present from the beginning, have only become apparent over the past few years.

The euro is predicated on the false assumption that a group of countries with widely divergent trade balances, debt levels, budget deficits, productivity levels and economic policies can achieve balanced growth under a common currency. Rather than serving to balance the divergent aspects of the various countries’ economies, the euro has only exacerbated the imbalances that existed at inception.

An example of how the euro has magnified imbalances across Europe is helpful in recognizing the flaws in the current system. Germany, the largest economy in the eurozone and an export powerhouse, generates consistent trade surpluses, has highly productive workers and runs modest budget deficits, all of which place upward pressure on the euro.

In contrast, several countries in southern Europe, including Greece, run persistent trade deficits, have low productivity and operate with large budget deficits. A weaker euro would reduce the trade deficits in these countries, make their low-productivity workers more competitive on a global basis and place pressure on their governments to reduce spending. However, because these countries share a common currency with a much larger country with policies that place steady upward pressure on the euro, the imbalances in southern European countries cannot be corrected through currency devaluation.

Instead, the strong euro, coupled with the lower interest rates the common currency caused, has served to elevate trade deficits, reduce worker competitiveness and incentivize higher budget deficits in peripheral countries. This has led to the current situation in which Germany enjoys low unemployment and robust growth, while peripheral economies remain trapped in a state of high unemployment and economic stagnation.

If peripheral countries operated their own currencies, managed as floating exchange rates, movements in various exchange rates would correct the imbalances outlined above. However, under the common currency, this natural adjustment mechanism doesn’t exist, leading to persistent imbalances and subsequently, the current existential crisis in Greece, with the potential for similar crises down the road.

What are the near-term implications?

Short-term, the possibility of a resolution where Greece remains in the eurozone is predicated upon a “yes” vote and the formation of a coalition government that is willing to implement the reforms creditors demand. However, this would only be a temporary solution with problems arising again and again in the future, due to the inherent flaws in the eurozone structure that I outlined above.

While the European Central Bank (ECB) now holds a broader range of tools – allowing the central bank to intervene more aggressively in markets through purchases of peripheral sovereign debt – these tools are designed for crisis management, rather than as long-term structural solutions.

Elevated equity valuations across Europe imply significant downside risk at this point. Investors have not adequately discounted the potential downside risks in cyclical sectors, such as southern European banks, where capital levels depend on sovereign bond valuations and deferred tax credits. One cannot rule out the current crisis spreading to other countries on the periphery, as the notion that euro membership is irreversible has been tested.

How are Trimark funds positioned?

Trimark Europlus Fund and Trimark Global Fundamental Equity Fund/Class are, and have always been, conservatively managed, with a focus on top-tier global businesses. The Funds don’t currently hold any companies based in Greece, Portugal, Spain or Italy. The Funds also don’t own any eurozone banks right now and are overweight more stable sectors, such as consumer staples.

Trimark Europlus Fund

Recognizing the elevated valuations and potential downside risks, Trimark Europlus Fund has been operating with elevated cash levels. Further, the Fund has stayed away from cyclical sectors and high-risk countries. This conservative approach should serve the Fund well during a downturn and allow the Fund to capitalize on opportunities as they arise.

  • Current cash position is 16.8%
  • Current currency exposure approximately 20% EUR (fully hedged), 10% CHF, 30% GBP, 3% DKK and 19% USD
  • The Fund doesn’t currently hold any companies based in Greece, Portugal, Spain or Italy
  • Estimated indirect exposure to Greece (companies in the portfolio with revenue coming from Greece)  is less than 1%

Trimark Global Fundamental Equity Fund/Class

  • Current cash position is 2%
  • Currency hedging: 50% hedge on the euro  and the Yen
  • The Fund doesn’t currently hold any companies based in Greece, Portugal, Spain or Italy
  • Estimated indirect exposure to Greece (companies in the portfolio with revenue coming from Greece) is less than 1%

We will update you on our positioning as developments occur. If you have any questions, please leave them in the comments below and I will do my best to answer them in a timely fashion.

Note: All fund data is as at May 29, 2015. Source: Invesco Canada.

 

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