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Investment
Quarterly - Q3 06:
Currency as an asset class |
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| Whether
an actively managed segregated mandate, or one of the new
unitised funds now available, Iain Morse investigates the
benefits of currency as an asset class in its own right, and
the various ways it can be managed to produce the best returns |
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Promising
returns with a low correlation to other asset classes, currency
has come into its own right. It is being used by a growing
number of larger pension funds and charities to generate absolute
returns and to diversify existing portfolios.
But active currency management is not widely understood. Part
of the reason for this is its complexity. Currency traders
do not measure their returns in relative, but in absolute
terms. Risk and return tolerances are agreed in advance with
the investor. Active currency management also polarises around
two core approaches, fundamental or technical, although in
truth most managers use a combination of both to varying degrees.
“Technical trading is driven by past exchange rate data,
and fundamental trading by economic market data,” observes
Bill Muyskin, senior consultant and currency expert at Mercer
Investment Consulting. Each approach can be further characterised
as predominantly quant or judgemental. Quant uses pre-programmed
trading; judgemental, as its name implies, allows for decisive
human intervention.
Of the 117 managers measured by Mercer in their currency universe,
most use some blend of technical and fundamental. By the same
token, even the most rigorous quant must allow for intervention
when unique, market-moving events take place, and the most
opinionated judgemental manager will still consult a model
against which to test themselves.
This highlights a fundamental point about the active management
of currency. “There is no single process or style that
you can say is dominant and best,” argues Mike Victoros,
head of global FX products at ABN Amro. “We have been
lucky that our relatively judgemental approach works well
in the current environment.” Some examples bear this
out. At Oppenheim Asset Management, one of Germany’s
leading active currency managers, only 15 currencies are traded,
mostly developed ones. “Our model throws out a plus,
minus or neutral,” says their currency chief Christian
Walde, “We can go against it within pre-determined limits.”
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Meanwhile Credit Suisse Asset Management has a somewhat different
decision taking process. This attributes 60 per cent of each
decision to fundamentals and 40 per cent to behavioural or
short-term factors. Within the 60 per cent, more than half
(35 per cent of total) is attributed to macro-economic variables,
10 per cent to aggregate flows of money, and 15 per cent to
fundamental quantitative analysis and forecasting. Of the
remaining 40 per cent, just over half (more than 25 per cent
of total) is technical analysis using charts, and the remaining
15 per cent to market sentiment. By contrast to Oppenheim,
CSAM trades more than 20 currencies, particularly emerging
ones, and they expect to increase this number in future.
These two examples illustrate the difference in sophistication
between the models used by different managers. For instance,
managers no longer only form their views on currency pairs,
but some instead take an absolute approach, valuing currencies
individually then blending these valuations into pairs. Research
from Hymans Robertson finds that managers are split almost
equally between pairwise, absolute and some blend of the two.
Needless to say, the size of the set of currency pairs traded
by any manager is an important clue as to their resources
and aspirations. As a rule of thumb, this market breaks down
into two groups; those that trade only developed currencies
and those that trade a wider range including the main emerging
currencies.
Charities seeking exposure to actively managed currency have
the same options as UK pension schemes. Segregated mandates
require a small initial cash commitment because of the leverage
used by the currency traders. However, investors must pass
a credit worthiness test because if the manager loses money
on their account, the investor has to pay up the relevant
amount. In good years, of course, investors receive profits
from the currency manager.
A growing number of managers, including BGI and PIMCO, already
have or are launching unitised currency funds. These actively
trade currencies but like any other unitised fund the investors’
total exposure is their initial investment. Also, trustees
need to do far less due diligence and do not need to construct
a detailed mandate. Either way, currency deserves consideration
for use as a new asset class by UK charities.
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