Liquidity attracts investors to forex markets

Investors are increasingly turning to foreign exchange markets in search of liquidity and diversity, bankers say.

The financial crisis has wreaked havoc across all asset classes, with credit, equities and commodities hit especially hard. However, some analysts say investors that have been stung in these markets are turning their attention to forex as a source of returns and a means of diversifying their portfolios.

Ritika Dhamija, head of foreign exchange structuring for Europe, the Middle East and Africa at Barclays Capital, attributed this trend to the liquidity and short settlement period of forex markets - factors that have become increasingly important in the stressed market conditions of recent months.

"The fact that equity markets have been very unstable in the past year has led investors to consider other asset classes. Forex has attracted particular attention because it is very liquid, and this has become more important than ever given the experience some investors have had with alternative investments, such as hedge funds."

"With transparency and liquidity gaining such a premium, forex is very popular because there are few asset classes like that," agrees a London-based director of the forex business for pension funds and insurers at a large European bank.

Andrew Kaufman, head of forex structuring at Barclays Capital, has also noticed a change in investor appetite. "Two or three years ago, when selling products to clients, I would mention the liquidity that a forex investment can offer but it was rarely of interest to them. Now it is the first question they ask," he noted.

Not only do investors want liquidity, but they also want simple and understandable products, Kaufman added. "Considering the events of the past few years, investors are looking to invest in asset classes with underlyings they feel familiar and comfortable with." Forex, he continued, fits this criterion.

A report by the Office of the Comptroller of the Currency on the trading and derivatives activities in the fourth quarter of 2008 of all insured US and commercial banks and trust companies recorded that "foreign exchange contracts continue to provide the most consistent source of trading revenues", rising 32% to a record $4.09 billion.

This trend has continued into the first two quarters of 2009, Kaufman said. The instruments that are most popular for gaining exposure to forex are principal protected notes, which are attractive because they limit downside risk, he explained. In addition, new investors less familiar with forex are looking to access the asset class through forex indexes and the range of instruments linked to them, such as total return swaps, certificates and funds.

Dhamija believes this appetite for forex will continue, even when returns in other asset classes improve. "In the short term forex has gained popularity because of what is happening in other asset classes, but in the longer term investors are starting to see forex as something that should be part of their portfolio and this is unlikely to change, even if equity markets rebound."