It can be difficult for any bank to distinguish itself in terms of structured product innovation in what is by far the world's largest, most transparent and most liquid financial market - the currency market. To stand out from the crowd, therefore, you have to do more than just put together pay-offs linked to underlying currency scenarios. And Deutsche Bank has gone the extra mile to do just that.
The German powerhouse has led the way in developing indexes that let investors capture the arbitrage opportunities available in currency markets. No other investment bank has made such opportunities so easily investable through structured products, demonstrating that FX can be regarded as an asset class in its own right, an assumption that remains controversial.
But Deutsche, through its development of sophisticated foreign exchange indexes and structured products written on the back of them, has challenged investors to fundamentally rethink how they view the underlying itself. And it's the bank's success in taking cutting-edge research and turning it into actual products that investors want to buy which makes Deutsche stand out as a leader in foreign exchange.
"It was really Deutsche that created a lot of the discussion about how FX is worthy of consideration as a separate asset class," says Rashid Hoosenally, the bank's London-based global head of the client strategy and solutions group. "You can argue that FX is an asset class; you can argue that it isn't an asset class but rather a source of consistent portable alpha, with consistent excess return; or you can argue that active currency overlay in a multi-currency portfolio adds value, and so overlay managers add value. In essence, what you're saying is that people who are good at trading FX markets are able to consistently extract value and returns over time, and we've done a lot to document and illustrate why that is the case."
Unlike the equity and bond markets, the majority of participants in the FX market are there because they need to trade currency for business or trade reasons - international investors hedging portfolio risks, central banks and cross-border companies are not profit maximisers in the FX market. It is therefore argued that because most participants have to trade irrespective of price, there are always arbitrage opportunities in the market. Deutsche recognised this natural bias in favour of active FX profit maximisers, and around five years ago started to develop investable indexes which could be accessed in note form to take advantage of it.
First came indexes based on a trade-weighted index, and thematic indexes. Then, last March, the bank launched its groundbreaking FX Select, which offers investors exposure to the aggregate performance of 65 forex managers, consisting of hedge funds, commodity trading advisers and overlay managers. "After only one year, we now have approximately $1 billion in the index, which makes it by far the biggest currency platform in the market," Hoosenally says.
This summer, Deutsche launched its Harvest series of indexes, which seeks to give buyers a carry play in FX using a single investment. "We looked at some trading rules that would be interesting to clients and we came up with Harvest. In effect, it's a dynamic basket," says Hoosenally. "You look at the high yielders, you look at the low yielders and you adjust." There are three variants of the strategy. The benchmark is the Global Currency Harvest Index, which invests in the world's five highest-yielding currencies and goes short the lowest-yielding. The Balanced strategy invests in the two highest-yielding G10 currencies and the three remaining highest-yielding currencies from the global pool, while going short the two lowest-yielding G10 currencies and three lowest-yielding from the global pool. The G10 strategy invests in the three highest-yielding G10 currencies and goes short the three lowest-yielding G10 currencies.
Another idiosyncrasy identified in currency markets is persistency of carry, which bodes well for Harvest, and also suggests the existence of some kind of systematic beta. This is at the absolute cutting edge of FX and, as usual, Deutsche Bank is leading the way.
WHY DEUTSCHE BANK WON
Deutsche Bank has produced cutting-edge research that supports the arguments suggesting that foreign exchange is an asset class in its own right. The bank's commitment to making the currency markets investable knows no bounds.
The week on Risk.net, December 2–8, 2017Receive this by email