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Foreign Exchange

Alpha, beta, gaga

In a way, a debate over alpha and beta separation – a debate that happened in equity fund management 20 years ago – is indicative of the arrival of currency as genuine source of return. James Binny, head of Index Research, RBS Global Banking and Markets

When I started as a currency fund manager 19 years ago, the concept of actively managing currencies was regarded as a little weird – why bother when there was an equity market? The fact that my team used quantitative techniques pigeonholed us into our own strange niche. Now quantitative techniques and filters are used to a greater or lesser extent by most fund managers. In addition currency management is, or is close to, a mainstream investment mandate for institutional investors. With that maturity and the move to the mainstream comes a question: Just as equity beta can be obtained by index or tracker funds, can the standard inefficiencies of currency markets be obtained by accessing lower cost indices?

RBS has published its Naive currency indices since 2004 both independently and at FXTP – and now RIND – on Bloomberg. Other banks have also subsequently produced similar indices. RBS will soon be producing investable versions of the indices, which will have better portfolio construction and risk management. These indices are designed to illustrate the simple inefficiencies available from taking currency investment decisions. The sources of return are: value, yield, momentum and short volatility. As we showed in a paper1 in 2005, each strategy has had periods of good performance.

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