Hedge fund investor bemoans lack of pure currency hedge funds

By:
Solomon Teague
Published on:

A lack of attractive investment opportunities in pure currency hedge funds means investors looking for FX exposure might be forced to invest elsewhere.

Fund managers at FQS Capital Partners, a London-based fund of hedge funds, are among many that have bemoaned the current lack of quality pure currency hedge funds.

Aref Karim-160x186
 In the past, trading currencies was relatively simple … Today, it is much harder to know how important any one factor is at any time

Aref Karim,
Quality Capital Management

Pacome Breton, head of portfolio management at the firm, says: "We have been looking for a long time and since inception we have not once found a pure currency fund that compelled us to invest in it. It is a mystery why, with so many smart people trading FX, we didn’t identify one that generated high and consistent level of alpha.

"But we like niche players or funds that specialize in only one asset class, as we diversify anyway by investing in different hedge fund strategies. So we are open to investing in such a fund and will keep looking."

Investors looking for currency exposure via hedge funds have other options. Global macro funds invest across a range of asset classes, including currencies, as do CTAs – systematic trend-following funds.

Allocations to FX vary in such strategies depending on the markets. They were relatively high in 2014, but look to have tapered off a little this year.

Breton says: "Macro funds started increasing their allocations to FX from around 2013, when many started shorting the yen, and last year FX was a massive profit generator for many of them, especially in the second half of the year.

"This year, a typical macro fund is up around 3% to 5% and likely to have generated half of that return from FX positions typically generated in January."

He adds: "The macro funds we follow have had large allocations to FX for the past 12 to 15 months. In the past, fixed income has often been their real bread and butter, but right now FX has become a major allocation."

Quality Capital Management (QCM), a UK-based global macro hedge fund, is a case in point.

Aref Karim, CEO at QCM, says: "In 2014 until around September, we had 30% to 40% of our portfolio’s risk weighting allocated to FX. Now it’s around 12%, but as the trends start to pick up we will buy in again."

It is a similar picture for the CTAs.

Philippe Ferreira, head of research for Lyxor Asset Management’s managed account platform, says: "FX was an important part of the returns for momentum managers last year, when we saw sustained trends from the dollar, euros and sterling.

"But over the course of Q1, these trends have been less strong and many managers have started to unwind their positions and FX is contributing less to their performance."

Ferreira says at the end of 2014 systematic managers had an average net short position of around 60% to 70% of net assets in euros against the dollar, but that has been reduced to around 25% to 30% and might fall further still.

Correlations

This is interesting for hedge fund investors, who might be eyeing correlations between underlying funds and strategies they invest in.

Ferreira says: "Discretionary macro managers often have very different exposures to trend followers. For example, CTAs are net short commodities, while discretionary managers are net long.

"But in recent months their positioning in FX has been very similar, though discretionary managers have tended to be less aggressive. There is broad consensus in the FX markets."

That consensus has seen macro managers gravitate to short positions in euro, yen and sterling, while it is increasingly difficult to avoid being long the dollar.

QCM’s Karim says: "It is a logical trade. You have the US, a safe haven, the strongest economy, with rate-hike prospect. And you have political and economic trouble in Europe with a slow economy. The contrast is huge and it forces you to back the dollar."

However, as popular as it is, it is not the only game in town.

"Some managers are active in emerging markets (EM), especially the more liquid currencies, such as the Mexican peso, Turkish lira, Korean won and South African rand," says Lyxor’s Ferreira.

"But these are minor exposures for large macro players compared to their trades on mainstream currencies. EM FX exposures only tend to be more significant in the portfolios of smaller, specialist FX managers, rather than the large global macro players."