Delegate biographies: Learn more about the panelists
|
Executive summary
• At worst, the credit crisis will have a neutral effect on FX; at best, it will provide new opportunities in the sector
• The crisis has brought higher volatility, involving difficult adjustments to FX models
• High volatility is to be expected when it is not clear what central bankers are going to do when they are themselves uncertain
• Clients are moving away from traditional mandates towards greater allocations to absolute return
• There is room in different circumstances for both electronic and voice trading |
AP, Intelligence Capital Clearly the credit crunch is the big, generic story. How much of this spills over to foreign exchange in terms of banks’ risk appetite, their involvement in the industry, trading, your counterparty relationships, the services they offer you?
AB, GSAM I’m hoping that it could have positive implications: structured finance is shut and that was a big area of revenue for the banks. Now, the beauty of foreign exchange from a bank perspective is that it doesn’t use up balance sheet like securities businesses, so in that regard it should be seen as a potential growth area. So, far from banks retreating, perhaps they will commit more capital to this area.
DT, Insight Investment Well I go on history and going through a couple of these cycles, I haven’t really ever noticed much of a change. As Andrew says, foreign exchange is a transaction-based service and banks make their money through volume rather than having to warehouse risk, so I don’t see it necessarily impacting foreign exchange much. I think maybe there will be some knock-on effects with prime brokerage and we will see higher credit requirements for hedge funds. But if you’re purely involved in foreign exchange, unless you’re very highly leveraged, then the current crisis shouldn’t really affect you too much.
AP, Intelligence Capital About four or five years ago some people would have talked about the possibility of banks being partly replaced by the ECNs or the equivalent, with the buy side trading with the buy side. Will the credit crunch push more volumes out to the electronic platforms or will it have no effect?
GK, State Street Investment managers have embraced electronic trading for efficiency gains and as a means of slimming down the numbers of people that are required to trade and settle foreign exchange. I don’t think that they view electronic trading as a way of disintermediating the banks. One of the enormous benefits of electronic trading is that it has allowed firms to offer more tailored services, because they are not spending valuable time on quotidian back-office tasks such as booking thousands of trades. Machines do that better in any case. From a management point of view it allows you to focus on building better, higher-quality relationships with institutional investors. Electronic trading is not a threat to banks that have a deep understanding of the needs of their clients.
AB, GSAM But I don’t think we should kid ourselves, the liquidity on the electronic platform mainly comes from the banks and from the algorithms that the banks are running. So electronic trading has been a great help, but it’s dependent on the banks actually providing the liquidity for it.
The volatility environment
AP, Intelligence Capital The crisis has altered the environment from a low to a high volatility regime, with the added strong trend in the dollar and the commodity currencies. How have quantitative and qualitative strategies held up?
JG, JPMorgan AM I was surprised how long it took for quantitative processes to encounter a phase of more negative performance. Carry-oriented processes outperformed during the era of low and falling volatility and this continued into the initial phase of the sub-prime crisis. However, the scale of the spike in volatility, the associated unwind of short yen and Swiss franc positioning and the use of FX as a hedge against underperforming mortgage and corporate credit-related investments ultimately created the conditions for a more sustained phase of adjustment. From a qualitative perspective, I was brought up during a period where you were paid a premium to offset potential capital losses, not to augment potential capital gains, and clearly for the past few years the latter has been the focus. This has led to a bias to high-yielding assets over low-yielding assets, and valuations got to a point where they couldn’t be sustained. The unravelling of that was always going to be messy, and the more widespread use of models may have contributed to this. The flip side is that it makes qualitative processes much more interesting and the diversification that they bring to investment processes is going to be more telling. So, looking forward, I’m quite excited.
AB, GSAM It’s a tough environment for quantitative models, but the quantitative approach to currency management remains valid. Most quantitative models are based on sound economic rationale – things that do matter for currency markets, such as being long carry. The models also use other factors, such as valuation, momentum, and economic performance – all of which will be important in driving currency markets.
DT, Insight Investment Last summer there was a rush of money into high-yielding assets that pushed the premium and volatility on high-yielding assets down, which enticed more money in, because return over volatility was the measure. It’s a virtuous circle until there’s a reverse, and that has happened in credit markets in particular, which has ramifications in currency markets, because the carry trade is simply the currency reflection of the global credit cycle. If you look back over history, you do get periods where carry trades return negative amounts, or negatively, for sequential periods, months, even years. So what’s happening in the currency markets is the same as what is happening in other markets, but with different letters and expressions attached to it.