FUND MANAGERS ARE beginning to take advantage of increased investor interest in currencies by capitalizing on their currency overlay teams to offer higher risk/return currency investments in the form of hedge funds. But some investors are sceptical about what these currency hedge funds have to offer other than an increase in fees.
Gartmore, Barclays Global Investors and GAM have all recently launched currency hedge funds. State Street Global Advisors is planning to do so in the second quarter of this year. Although several other currency managers, such as JPMorgan Fleming, Rhicon Currency Management and Bridgewater Associates, have offered such alpha-generating, absolute-return funds to investors for many years, the asset class is attracting renewed interest from investors and currency overlay managers.
As a result, the number of currency funds generally has been rising. The number of funds in The Barclay Group's Currency Traders Index has peaked this year at 72. This compares with 55 in 2003, 49 in 2002 and 47 in 2001. Sol Waksman, president of The Barclay Group, says: "The number of currency-only programmes included in our index has blossomed due to money flowing into the entire managed futures sector. Assets of the total managed futures sector in 2003 increased by around 70%." He adds: "Interest [in managed currency futures] peaked in 1995, then trailed off for eight years and now it's back up."
The assets invested in currency funds has also increased. In the third quarter of 2003, the 49 managers in the Parker FX Index had around $9 million in assets under management. By the middle of last month, the assets of those managers had grown to $11 million.
Currency management began as a way to deal with the currency risk created by investing in foreign assets. Then, about 10 years ago, investors began to ask their currency overlay managers to increase the alpha generation within these risk management programmes. Investors now seem to be interested in investing in stand-alone currency funds. Paul Duncombe, head of currency management at SSgA, says: "Currency overlay usually has about 3% active risk. A currency hedge fund has about 10% to 12% risk, and is about 3 to 3.5 times leveraged." Paul Skinner, head of fixed-income business development at Gartmore, says: "In order to get that sort of volatility (10% to 15%) you have to have leverage. Above about a 5% to 6% tracking error you have to start using leverage to get the returns."
Although currency overlay funds are restricted by the parameters of a client's account, currency hedge funds enjoy more freedom. "Every time you free up a manager, the information ratio improves. That's proven," says Skinner.
The significant dollar decline over the past few years has awakened investor interest in currencies in general at a time when equity markets have struggled and bond yields have been low. Thanos Papasavvos, currency strategist at Credit Suisse Asset Management, says the trend in the market over the past few years has meant managers have done well.
For the full year 2003, The Barclay Group's Currency Traders Index was up 11.06%. This was its best performance since 1997 when it was up 11.35% for the year. In 2002 it was up 6.29% and the index has posted positive returns for the past nine years. The Parker FX Index was up 19.06% for the 12-month period to the end of January. In comparison, the S&P 500 DRI Index was up 28.55% in 2003 but was down 22.19% in 2002 and down 11.89% in 2001.
In fact, the average manager in the Frank Russell universe with a five-year track record has outperformed. This is partly because currencies are so liquid, with a total daily turnover of $1.2 trillion, which means the costs of dealing are very low. In addition, non-profit maximizers, such as tourists, corporates and central banks, account for more than 75% of that daily volume. Another manager says: "In no other asset class do people just deal at the price they're given. They're willing losers, which allows us pros to make money out of them."
Investors have also been attracted by the lack of correlation that the asset class has with equities and bonds. Mark Rzepczynski, president and CIO of John W Henry - an alternative asset manager that is one of the largest managed futures advisers in the world - says: "The advantage of currencies is that the set of factors that could affect currencies are different for equities and fixed income." He adds: "For example, in the fourth quarter of 2003 the [US] dollar declined at the same time as there was a rally in fixed-income markets. Just because you say there's a connection between currencies and interest rates doesn't mean they affect performance."
As a result, managers feel that clients are ready to invest in pure, high-alpha-generating currency funds. "The progression from risk management to alpha generation has now gone to the stage where people are looking for high-level-alpha generation," says Skinner. "This is where the funds come in."
Most investors in currency hedge funds are funds of hedge funds. In fact, some managers have created dedicated currency funds of funds. For example, Julius Baer launched its Global Currency Opportunity Fund last November.
Pension funds and banks also invest in currency funds. Andrew Dales, director of currency research at BGI, says: "In the UK about 5% to 10% of pension funds are doing something with currencies on an active or passive basis." However, pension funds are taking a bigger interest in currencies. Brian St John-Hall, associate at Hewitt, Bacon and Woodrow, says: "Two to three years ago, if you said 'what about currencies?' it wouldn't have been in the top 10 of trustees' lists. Now it probably is."
One fund of hedge funds manager, says: "A lot of institutions give [currency hedge funds] money because it increases the volume through their FX desk. For example, [a hedge fund says] 'Give us $20 million and we'll trade it through your desk.' They make money and benefit from the transaction costs too."