With volatility in all markets very high and liquidity never guaranteed, FX is increasingly appealing to hedge fund managers for its consistent liquidity – in the major currencies at least – even in times of extreme market stress. And with many now concluding that the focus of the crisis is turning back to the banks, the fear is that liquidity might vanish from many markets outside FX as volatility spikes.
FX markets are also increasingly appealing to managers that are struggling to make returns in equity markets driven more by fear than by fundamentals. Bond investors are no better off, with yields remaining compressed, while liquidity in less-liquid bond markets, such as corporate bonds, is worsening.
This played out in hedge fund returns in August, where almost all equity strategies tracked by Hedge Fund Research, with the exception of the short-bias index, produced negative returns. In fact, most equity strategies haven’t had positive returns since April.
“I think there is a real lack of trust in stocks right now,” says Titus Schlosser, head of the alternative investment business at Portfolio Concept, a Germany-based asset management company managing dedicated currency funds. The currency markets also offer trading with minimal slippage, given their high level of price transparency and tighter spreads, which is a factor that can be quite problematic in other asset classes, adds Schlosser.
It is not that FX offers high or low correlation to other assets per se, but it is a market where hedge funds themselves might be less correlated, argues Schlosser. For instance, equity fund managers have a relatively high correlation to the equity market, whereas FX managers don’t have the same correlation to the currency market, he explains. That’s because there are many managers on either side of any given currency pair. Indeed two FX funds can have very different currency returns. “That’s very attractive to fund managers,” says Schlosser.
This idea seems to be playing out in Europe, or so anecdotal evidence suggests, at least, particularly among investors looking to allocate more of their assets to currencies. “We see more interest from investors now, looking for FX asset managers,” says Hendrik Klein, CEO at Switzerland-based macro fund Da Vinci Invest.
Indeed, it is in global macro funds that this interest in FX as an asset class is most likely to manifest itself. While macro funds trade all asset classes, FX is probably the single most important component of the overall strategy, says Ken Heinz, president at HFR, which tracks the performance of hedge fund strategies globally. Macro strategies, while largely flat year-to-date, have had two positive back-to-back months, HFR data show.
“I would expect currencies to continue to be a growth area for hedge funds, not least because of the general uncertainty surrounding the euro,” Heinz says. European and Asian funds have always had a greater focus on currency strategies than their US counterparts, he adds.
A total of 48 macro funds were launched in the first quarter, putting it on target to match last year’s 193 launches. Should launches surpass 200 in 2011, it would be the first time since 2006. Interestingly, macro liquidations are trending well below the average of the past two years, while liquidations on equity hedge funds are tracking the average of the past two years.
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| Source: Hedge Fund Research |
When comparing the performance of equity versus passive currency indices, it is noticeable that equity investors are taking on much more risk for the smaller returns, according to Sharpe ratios. For instance, the Dow Jones Industrial Average indicates an annualized return of just over 8%, while its measure of volatility is 16%. On an index made up of the Bric countries, which has a similar volatility, an investor yields a return of 17%. It is these dynamics that investors are only now beginning to understand fully, say index providers. Still, running a macro fund, and the skill sets needed to manage an equity long/short fund and to trade FX are very different. Managers turning their hands to FX, for example launching global macro funds or trading FX in a multi-strategy fund, are therefore likely to see mixed results, especially in the early days as they learn about the asset class.