Global currency managers are venturing far beyond the carry trade to diversify their sources of returns from the foreign exchange market, in yet another sign that the asset class is entering the next phase of evolution following the credit crunch.
“Alpha has become more sophisticated,” said Neil Record, founder and chairman of Record Currency Management Ltd., Windsor, England. “The future of currency strategies depends on the ability to understand why, as a group, we have performed so poorly (during the credit crisis), and to strip out the various effects so that investors are clearer about their investments.
“Currency strategies are becoming more like equities,” Mr. Record said, referring to the development of a currency “beta” benchmark. If the allocation is active, then investors should expect a return on top of outperforming that benchmark, he added.
As beta and alpha are being separated in currency strategies, active management is being scrutinized more closely than ever, sources said.
Managers are taking the cue by diversifying currency returns away from the carry trade, which was the basis for many active currency strategies before the financial crisis of 2008-2009. Carry trading itself has been changing in the past couple of years to include more volatility filters within many systematic models. Dynamic hedging, which involves varying exposures to certain currencies within a portfolio to better control risk or add returns, is also gaining ground.
In addition, institutional investors are focusing more closely on how currency can be used within broader strategies such as emerging markets debt, global fixed income and tactical asset allocation.
“A key lesson (from the credit crunch) is that it is quite important for active currency managers to have, at their disposal, a diverse portfolio of active strategies,” said Monica Fan, London-based senior currency product engineer at State Street Global Advisors.
Until the financial crisis of 2008-2009, investors generally saw currency exposure as “a necessary evil rather than an opportunity,” said Sean Shepley, head of fixed-income markets research at Credit Suisse Group, based in London.
“What's different now is that the perception of the relative market liquidity has changed markedly (since the financial crisis). ... The ability for (the FX) market to stay open even at extreme dislocations elsewhere is worth a lot and has led many investors to reassess how FX can be used to hedge valuation and liquidity risk elsewhere in their portfolios.”
The global foreign exchange market is among the most liquid, with about a $4 trillion average daily turnover in 2010, a 20% increase from 2007, according to a triennial report published earlier this month by the Bank for International Settlements, Basel, Switzerland.
“If you're looking to profit from the big macroeconomic moves, currency is a very good way to play that theme,” said David Curtis, executive director and head of U.K. institutional business at Goldman Sachs Asset Management in London. GSAM declined to provide currency assets under management, citing company policy.
“It's the largest, the biggest and the cheapest market to trade in,” Mr. Curtis added.
Institutional investors are beginning to issue RFPs in the active currency management again following “a quiet period” in 2009, said Neil Smith, senior investment consultant in the global investment practice at Hewitt Associates LLC based in London. At Hewitt, searches for active currency managers tripled globally so far this year compared to 2009, according to Mr. Smith. He declined to name the clients.