A currency without a past
Rachel Fixsen examines the issues that the Euro has brought for past performance
The advent of a single currency in Europe was unprecedented -- and it has raised some unprecedented problems. Here is one: How do you compare the performance of two euro mutual funds which used to be denominated in two different currencies?
“Now you have providers across Europe all competing for the same pot of money, and at the moment (their products) are not comparable,” says Mark Bramley, head of the performance group at Russell Mellon Analytical Services.
Financial analysts realised this type of comparison could be at best problematic well before the euro was introduced at the start of this year. The European Federation of Financial Analysts Societies (EFFAS) Permanent Commission on Performance Measurement drew up a set of guidelines in respect of the impact of euro conversion back in September.
Acknowledging that it would often be useful to show data in a continuous series including periods spanning the currency change, the group said that providers and users of performance comparisons would have to accept that euro conversion date would create a discontinuity in many cases.
Some clients would want to see historical values converted into euro at the fixed exchange rate for their local currency, EFFAS said, but it stressed that it was vital that this data always retained the label of its original currency. It said this should be worded as, for example, 'French francs converted to Euro at the fixed exchange rate' or 'FRF(EURO)'
One of its overriding principles was that fund performances which were not validly comparable before EMU could not become retrospectively comparable by virtue of the creation of the euro.
For example, a German bond fund could not be compared with an Italian bond fund before euro conversion date, and it is not comparable now. But there may be a need to compare the performance of a global equity fund managed in Italy, for instance, with that of a global equity fund managed in Germany.
As long as they are comparable funds with similar mandates, comparing two fund performances which are both in the same euro in-currency, say French francs, should present no problems.
However, difficulties would arise if the past performance of an investment fund previously denominated in one national currency within the euro group is compared with another in a different national currency. If both were presented in euro at the fixed exchange rate this would be highly misleading.
Foreign exchange fluctuations can materially change rates of return once investments are converted to another currency. So assuming the exchange rate between those two national currencies had changed over the period illustrated in the comparison, it would disadvantage the fund denominated in the currency which had weakened.
So how can you compare funds which used to be in two national currencies but which are now united by the euro? Glenn Bedwin, director of data strategy at financial information provider Datastream/ICV has outlined the various options for presenting pre-euro performance histories for securities and investments.
One could continue to use national currencies, says Bedwin. He acknowledges that quantitative analysis, for example, will need to have original data. Economists may also want to continue working in national currencies, particularly as it is unlikely that historical data will be available from national statistics offices in euro for some time, he says.
A second option -- restating historical performance data as euros at the fixed exchange rates -- invalidates international comparisons. A third option is to use reference rates, for example converting data in any pre-in currency to deutschemarks and then to euros at the lock-in rate. Bedwin says Datastream/ICV certainly see reference rates as the appropriate choice for international comparisons.
Another option could be to restate historical information in ecus. But Bedwin warns the ecu is a poor proxy for the euro, with sterling accounting for 13 or 14% of the the basket. Bramley agrees that the ecu is a bad substitute for the euro. “The basket changed quite regularly due to economic change in Europe,” he says.
If the ecu is no use, could a synthetic euro be calculated and used? Bedwin says the market had hoped, before the euro was introduced, that a single euro synthetic would develop. But the EFFAS report has been taken to mean that synthetics will not be useful when presenting data. “It is not that people will intentionally mislead clients, but it is manufactured... there's a danger,” says Bedwin.
Another reason why a synthetic euro would not be valid is that if the euro had existed two years ago, interest rates, trade relationships and GDP would all have been different, he says.
“Any pseudo currency can't avoid distorting this history for someone... because of the interplay between all the different exchange rates,” says Bramley. But he points out that some people will be compelled to use a synthetic euro, for example for value-at- risk models.
Depending which method you choose, the impact this has on historical information can be huge. Datastream uses the example of the share price of Italian car maker Fiat. If the price is restated in euro using the lire/euro fixed exchange rate, the share appears to reached a peak for 1991 which is 35% lower than if the price had been converted using the deutschemark as a reference.
“This is a single security -- imagine what happens when you compare securities,” says Bedwin.
“The best thing to do is to use a legacy currency,” says Bramley. “Either one of the previously existing euro currencies, or a currency outside the euro bloc altogether, such as the US dollar,” he says.
The sensible answer for fund managers with composites -- groups of like-mandated funds -- who wish to express past performance from a group of funds which are not all in the same pre-in currency, is to pick funds in the dominant currency and highlight their return, says Brian Henderson of the WM Company.
“Common sense should be applied... with the fund manager choosing the most representative currency in terms of number of funds and value of funds, otherwise this could be open to cherry picking,” he says.
One solution for European mutual funds is to avoid expressing their past performance in absolute terms at all. “There is one thing they can do, and that is to quote relative returns,” says Henderson. European equities funds could state their performance relative to the FT/S&P Actuaries (Europe ex UK), currency converting the index as appropriate, he suggests.
“The only spanner in the works might be if there is any degree of hedging going on,” he warns.
So how long will the introduction of the euro remain a stumbling block for performance comparisons? Perhaps in three to five years' time there will be enough historical performance data for investment funds which is genuinely in euro, that the solution will become not to even try comparing them before 1999, says Bramley.
Dugald Eadie, chairman of the EFFAS Permanent Commission and managing director of Henderson Investors, says since the guidelines were issued, there have been no hiccups and everyone is in agreement about the theory. But, he adds, they will not know until the end of this calendar year what the practical problems have been. When people start to look at the performance for the year 1999 and want to try to look at a three year record is when, the issue will come to a head, he says.
Rachel Fixsen is a freelance journalist