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Foreign Exchange

Fund managers make the case for dedicated FX

FX managers see growth in active currency hedging and alpha-generating FX funds in the years ahead.

FX hedge fund managers are hoping to win back the investors they have lost in recent years through lacklustre performance.

The hedge fund universe has never been awash with pure FX funds, but their numbers appear to have peaked around 2008, at which time BarclayHedge, which tracks hedge funds, monitored 145 of them – the high watermark for the strategy.


 The real growth for specialist FX funds

will come from [the

active hedgers]

Richard Benson,
Millennium Global

Since then, it has tracked less each year, down to 82 in 2015, less than it monitored in 2005.

In performance terms, according to BarclayHedge, 2008 was the best year for FX funds, when the sector delivered 3.5% for the year, at a time when hedge funds running the equity long/short strategy were being slaughtered, losing 11.88% for the year.

Macro managers, which trade FX as well as other asset classes, fared far better, delivering 12.17% in 2008.

However, since then, FX funds have not done so well. They made 3.45% in 2010 – less than the other two aforementioned strategies. For several years post-crisis, FX funds struggled to deliver more than 1% and only in 2014 did they again break the 3% barrier.

Nevertheless, equity long/short funds have been more volatile, with a 4.58% loss in 2011, and double-digit returns in two other years since the financial crisis.

On a risk-adjusted return basis, the performance of FX funds relative to other strategies has been mixed.

However, more importantly, it’s easy to forget the asset class is still in its infancy compared with traditional stock investing. Fund managers are redoubling efforts to market the unique appeal of FX and are innovating fund structures as investor demands increase in complexity.

Richard Benson, co-head of portfolio investments at Millennium Global, says there are three main types of investors in FX products, which he likens to parts of a cup cake: the casing, the cake mix and the icing.

The first group is the passive investor, those with unwanted currency risk they wish to mitigate – the casing. The second group, the active hedgers, are the cake mix: those that want to mitigate FX risk while generating the additional uncorrelated alpha active management can provide, he says.

“The third group are those without any currency risk, but who seek the alpha from active currency management which tends to have extremely low correlation to their traditional allocations,” says Benson. “Those wanting to generate pure alpha from FX are the icing for the specialist currency management industry.”

FX requires a very different mindset to
investing in equities long-only

James Wood-Collins, Record

Passive products are not very exciting and strategies tend to have very low fees, says Benson, while those seeking alpha are the most profitable clients.

“But I think the real growth for specialist FX funds will come from the second group [the active hedgers],” he says.

Millennium Global cites recent Reuters reports that US pension funds have lost $1 trillion through not managing their FX risk over a nine-month period. That is a massive potential demand for currency overlay services.

And with EUR/USD volatility now twice the level it was two years ago, that risk – and opportunity – is higher than it has been for years.

The difference

FX is different to other asset classes that makes investors wary of investing in pure FX funds. FX is not an investable asset class that offers tangible upsides. In other words, if you buy and hold a portfolio of currencies, you might not expect to make a return, in the way you would investing in equities or bonds, via dividends or yield.

If FX managers continue to perform and attract investors back into the product, dedicated FX funds – as opposed to hedging FX risk in equity funds, for example – will appeal to a certain type of investor who is already familiar with this way of investing.

A separate account – where a fund manages an FX position for a client on a bilateral basis, rather than collectively in a fund – offers more flexibility than a fund, but will not appeal to all investors.

To go this route, investors must arrange more of the infrastructure themselves, says James Wood-Collins, CEO at Record Currency Management.

“They need credit lines, they might need a prime broker, they need to manage a portfolio of forwards in their own name,” he says. “Some investors like this transparency at the position level, but others prefer the convenience of the fund structure.”

Millennium Global’s Benson agrees the two appeal to different types of investors, and the growth of one is unlikely to be at the expense of the other.

“They are very different types of investor, especially because actively managing FX risk tends to be done on an unfunded basis,” he says.

A creditworthy investor, such as a pension or sovereign wealth fund, can use forwards putting no money upfront, so there is zero tangible capital consumption, though risk has been taken. That is likely to appeal to a different type of investor to the one that has money to put to work and is looking to maximize returns.


James Wood-Collins,
Record Currency Management

Record’s Wood-Collins says: “The ability to run a strategy on an un-invested basis is really unique to currency. Combined with the nature of its uncorrelated returns and liquidity characteristics, it is a tremendous attribute.” Even for those familiar with the fund structure, an FX fund might therefore remain a mystery for many investors.

“FX requires a very different mindset to investing in equities long-only, where management is about stock selection and weighting,” says Wood-Collins.

“But it has more in common with investing in equities long and short in hedge funds, where managers can hedge out market beta and make relative value plays within a sector, for example.”

Wood-Collins says demand for return-seeking strategies is increasing, adding: “Our most successful strategies have always been those developed in partnership with clients – pioneering strategies that start off being managed as a separate account, specific to each client.

“Our forward rate bias strategy started out this way in 2003. It was only later when it had a track record that it was launched in a pooled fund structure, with clients who were more inclined to invest in a standardized product.”

He predicts the market is now in the phase of early adoption, with more investors set to come in as returns improve, and more funds to appear as investor interest increases.

“We are back to the early stage after a five-year hiatus,” he adds.

As people get more familiar with FX, interest in hedging or alpha-generating products should increase.

Benson says interest in active hedging comes principally from institutional pension plans, while demand for FX funds is more likely to come from traditional hedge fund investors.

“For FX alpha funds to grow, they will have to attract investors from other hedge fund strategies, not from corporate pension plans,” he says. 

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