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Foreign Exchange

Fund managers reassess merits of currency investing, report says

More investors are finding that active foreign exchange strategies might be better suited as a supplementary strategy rather than a core strategy for seeking alpha, according to Pensions and Investments (P&I) online magazine, which cites asset consultants and pension executives.

That puts the onus on currency managers to prove to investor clients that they can deliver added value with their strategies, says the publication. However, the average active currency manager underperformed in 2011. Active currency management falls under two general categories: absolute-return or hedge fund strategies that aim to deliver currency alpha independent of the client’s existing currency exposures; and dynamic or active currency overlays in which managers take positions relating to the underlying portfolio’s existing foreign exchange exposures.

For many stand-alone active currency managers, the “risk on, risk off” trading environment has been tough. In 2011, active foreign exchange managers returned on average -6.17%, as measured by the Parker Global Currency Managers index, a multi-manager-based index developed by Parker Global Strategies LLC combining macro discretionary, model-driven and diversified strategies, says P&I.

In comparison, P&I says that global macro, managed futures and global tactical asset allocation strategies — all of which include currency risk as a key return driver but not their only one — have generally topped other hedge fund styles in 2011. For example, the HFRX Macro/CTA index returned -4.88%, outperforming both the Parker Global CMI and the broader HFRX Global Hedge Fund index, which declined by 8.87% in 2011.

Still, 2012 has been a better year for active currency, with managers in the Parker Global CMI averaging a 2.56% excess return for the first two months of the year, says the publication.

There has been continuing debate about whether currency investing offers diversification in portfolios. It does, according to a Swedish investment firm interviewed by P&I.

Investment executives at AP Fonden 2, Gothenburg, Sweden, are developing ways to better understand currency-risk characteristics to enhance returns within its new alternative risk premiums portfolio, says Tomas Franzén, chief investment strategist at the SKr216 billion ($32.2 billion) fund, in the article.

Currency trades will be a key part of the alternative risk premiums strategy, which will also include other return drivers such as interest rates. The portfolio will initially account for about 1% of the total portfolio, but could rise to 5%, Franzén tells P&I.

Managers that did well in 2011 include those “with models that can adapt rapidly to a changing macro or risk environments”, says Matthew Roberts, investment consultant at Towers Watson & Co, London, in the article.

Some have added more risk-management factors to their systematic models to target more consistent outperformance, sources say. Others are broadening the opportunity set to include more emerging markets and even frontier markets currencies, states P&I.

In addition, there is “a resurgence of blended currency strategies, combining systematic and discretionary” approaches with fundamental inputs, Jon Stein, managing director of FX and macro strategies at Parker Global Strategies, Stamford, Connecticut, tells the publication.

Along with developing investible currency manager indexes, Parker Global runs multi-manager currency strategies totalling about $3 billion in assets under management.

Other currency managers are also tweaking existing strategies. The article cites Record Currency Management, a long-standing participant in this market, as introducing a risk-aversion component to the firm’s return-seeking active currency strategies in the third quarter of 2011.

Meanwhile, P&I also quotes Adrian Lee, president and chief investment officer at Adrian Lee & Partners, who says his firm was considering adding six more frontier (markets) currencies, to its exiting 18 frontier currencies.

The article also highlights dynamic hedging as one of the bright spots for currency managers. This is the result of a sizeable overseas shift of asset allocation by investors. Pierre Lequeux, head of currency management at Aviva Investors, tells the publication that at the end of March his firm managed about $2 billion in active currency overlays, with an average information ratio of 0.3 – a measure of how much alpha is generated per unit of risk.

Currency volatility has contributed as much as 35% of the total volatility of a typical international equity portfolio and 70% of the total volatility of an international bond portfolio, according to data from State Street Global Advisors. It is a fundamental part of the portfolio, not an optional strategy, Collin Crownover, the head of State Street Currency Management, tells the magazine.

In dynamic hedging, managers might customize the hedge ratio of individual currency exposures within a particular investment portfolio, and adjust that ratio accordingly to minimize volatility and potentially add returns under different environments.

Investors could gain as much as 100 basis points per annum when dynamically hedging about half of the overseas equities exposure, according to several sources.

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