March proves cruel month for FX

foreign exchange

The trend towards launching of funds of foreign exchange funds has continued recently, with new products coming to market from the likes of multi-manager Russell Investment Group.

Russell Investment Group has launched a multi-manager FX vehicle, domiciled in Dublin, called the Active Currency Fund. It will be traded daily and be UCITS III-compliant, with share classes for dollar, euro, sterling, and yen investors.

It aims to beat Libor, primarily using currency forwards. The fund will combine three managers with complementary investment styles - BGI as a fundamental manager, Pareto Partners as a technical manager and FX Concepts as a hybrid fundamental/technical manager.

While Russell said BGI's developed- and emerging-markets processes incorporate fundamental factors including valuation, portfolio flow, interest rates and momentum, Pareto Partner's process "aims to capture trends in the major currency pairs, while FX Concepts operate in the developed markets with a hybrid process based on interest-rate fluctuations and technical factors."

Alison Ramsdale, Russell Investment Group's managing director, product development, EMEA, says while currency managers will add alpha over the cycle, "the incidence of them adding it will usually vary. Intelligently combining multiple managers generates more consistent alpha with a lot less volatility," she adds.

Russell Investment Group has scenario tested its chosen managers against a range of macro-economic factors; different interest rate environments, growth conditions and volatile climates, "giving you a fairly good sense of what a manager's performance will look like when they go live." Ramsdale says FX is one of few remaining inefficient asset classes, with many market participants operating without profit motives; hedging trade flows for example or simply tourists exchanging currency for holidays. This being the case, the FX market offers great opportunities for the savvy.

"Market opportunities in FX tend to be episodic," she adds, "but over the long term, there's really good value added. In fact, unusually for asset management more generally, it's rare to see even the median manager underperform the benchmark over the long-term.

"Our clients are increasingly interested in cash-plus, portable alpha, and active currency strategies. Currency is a good asset class to add to a portfolio because it offers returns uncorrelated to more traditional asset classes."

However, Ramsdale says, it is important investors are aware of the more 'lumpy' return patterns of active currency management. Not unlike those produced by global tactical asset allocation (GTAA), active currency returns tend to be characterised by long periods of modest performance peppered with sudden bursts of return when managers' ideas and the markets came together, she says.

Russell Investment Group's multi-manager active currency fund targets gross returns of Libor plus 2%-3%.

However, fund launches are taking place after returns from currency have had a rough month. In March, most FX funds had trouble generating profits, says ABN Amro.

In the institution's naive simulations of currency management styles, trend-following strategies did worst, with an average 2.3% decline. Short volatility was down by 0.1%, yield-based strategies by 0.2% and the value-based strategy was down by 0.3%.

March was an "extraordinarily difficult month for currency managers," said James Binny, executive director of FX analytics and risk advisory at ABN Amro.

The fall of all four styles has happened only five times since 1975, when the ABN Amro data begins. The other times were October 1975, November 1979, June and July 1986.

The trend-following strategy performed worst, as major currencies displayed volatile behaviour with little net movement. The only strategy to generate profits was the Australian/US dollar, which was more persistently weak, Binny says.

The yield-based strategy also fell as the 'carry trade' generally failed, he adds. In ABN Amro simulation, this was caused by short positions in Sweden's and Norway's krona, and a long on the Australian dollar.

Binny added that with option-implied volatilities remaining low, there were few opportunities for short volatility-focused strategies.

"The only currency where the strategy had sold options at the start of March was the yen. These expired in the money, thus generating a small loss," he added.

However, more heartening reseach has come from Barclays Capital's Equity Gilt Study 2006.

The study takes an example of a portfolio with three assets - one risk-free asset (such as cash) and two risky assets (an equity and a bond index), and asks if it's sensible to add a fourth asset to the mix. "The specific answer would depend on the expected return of this asset, (and) its volatility (variance) and correlation with the other risky assets in the portfolio," the study notes.

"The fourth asset would be particularly attractive if it had a high expected return, low variance and negative correlation with the other risky assets in the portfolio."

If the extra risky asset displayed an expected return "no different from that of the risk-free asset" it may still make sense to include it, Barclays adds, "as long as the fourth asset is not perfectly correlated with the other risky assets."

How does this general theory apply to FX, the study asks. "Our example (see graph, left) illustrates that even an investor who believes that there is no alpha to be gained by investing in FX may still want to hold non-zero currency positions because of their correlations with the other assets in her portfolio."


Multi-managers are still launching funds of FX funds diversifying between managers and styles.

Low correlation with other assets makes holding FX in a multi-asset portfolio a wise move.

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