Foreign exchange is finding new fans among hedge funds and global macro-focused asset managers, as ever-tighter correlations between currencies and other asset classes prompt investors to use it as a proxy for other markets.
A state of seemingly permanent crisis in the financial markets over the past year has forced all key asset classes to move in lock step with one another, leaving the correlation between the euro's exchange rate against the dollar and U.S. equity returns around historic highs. Oil and the euro are also unusually closely linked, while the Australian dollar's tie-in with global stocks is rock-solid.
To some investors, that is frustrating, because it hampers efforts to diversify returns. But others are taking it as a cue to trade currencies as a proxy for less liquid assets elsewhere.
"With the outlook for the euro-zone crisis still very uncertain, investors use the euro as a short-term investment proxy to express their view on which way the saga appears to be heading. Accessing the foreign-exchange markets is often much easier and cheaper than trading directly in a country's bond or equity markets," said Des Morris, head of U.K. institutional client service at Wegelin Asset Management Funds SICAV—part of Switzerland's oldest bank Wegelin. Wegelin Asset Management has 1.6 billion Swiss francs ($1.68 billion) in assets under management.
One London-based hedge fund manager, who didn't wish to be named, said that he sold the euro in the second half of last year as a proxy for stocks, because it was "a better macro play" with limited ways of losing too much money.
The Australian dollar is another key target. Chunky Australian commodity exports, particularly to China, leave its currency closely linked to global growth prospects, to Chinese growth and to commodities as a whole. That makes it attractive to investors keen for exposure to any or all of those elements.
"Trading the Australian dollar is a way of expressing many macro views, not just an Asia view. It's a nice way to hedge other exposures," said James Pearson, head of FX spot trading at Royal Bank of Scotland Group PLC, who added that liquidity in the currency is becoming sufficient to attract speculative traders.
Other banks agree that their clients are turning to currencies in growing numbers. "The S&P and the Australian dollar have a correlation of around 78%. So many clients are asking themselves: why trade the S&P? FX is open 24 hours a day, you can trade at speeds of 13 milliseconds, you have very, very low transaction costs, and you can trade in large sizes," said Anil Prasad, global head of currencies and emerging-market rates at Citigroup Inc. in London. "No major asset class experienced the type of volume growth we had in FX last year. For us, FX volumes grew by 30%, even more with some client segments like institutional clients and wholesale banks."
Citigroup is launching a new, faster currencies dealing system Monday, partly to help deal with these new clients. The system will handle only currencies at first, but is designed to bolt on new asset classes over time, starting with commodities and rates, and later, stock indexes and credit.
Still, crossing over into foreign-exchange isn't for everyone. The constantly shifting nature of correlations will make some funds skeptical of incorporating it into their trading strategies on a regular basis. Some funds are unable to stray into new asset classes under the terms of their mandate.
"It would depend very much on the fund. Some funds are limited by the percentage of their portfolios or a measure of value at risk," said Adrian Owens, an investment director managing fixed-income and currency-based hedge funds at investment firm GAM, which has $60.2 billion in assets under management and is part of GAM Holding AG.
Moreover, dabbling in currencies doesn't always generate returns. Far from it, in fact. Even currency-focused hedge funds, the supposed specialists, lost 3% on the year in October, according to the latest available data from Parker Global Strategies, which invests in currency hedge funds. Last year is widely regarded as a dismal time for currency traders.
Still, enthusiasts include global fixed-income and global macro asset managers, who tend to be keener than their counterparts in equities, according to Nick Spencer, director of consulting at investment firm Russell Investments.
read more: Olympus Wealth Management
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