Report from The Business Times (Singapore) dated Fri, Feb 11, 2011 Currencies: The next big thing
By Genevieve Cua
OVER THE LAST few years, currency has emerged as a big investment theme as the macro plays - a weak bias for the US dollar, a positive undertone for Asian currencies - have been strong and are often spoken of by strategists.
How can you benefit without actually trading currencies yourself?
Enter Henderson Global Investors with a new Global Currency Fund, a purely systematic or quantitative strategy that seeks exposure to currencies with the highest 'carry'.
The carry trade basically involves buying a higher yielding currency, using a low-yielding currency to fund the trade. The investor profits from the interest rate differential. There is, of course, currency risk in the trade. If the currency in which you are deposited in plunges, it could wipe out the rate differential.
Carry - the largest driver
There are roughly three drivers of currency returns over time - carry, momentum and valuation. Of these, carry has historically been the biggest source of return over the long term. But there are periods when it fares very poorly. 2008 was one such memorable rout. As risk aversion soared, the traditional carry trade reversed and caused huge losses as investors fled from higher yielding currencies such as the Australian dollar, and piled into the US dollar.
Singapore, incidentally, has seen less than a handful of dedicated currency funds. Two have actually closed in the last year or two, partly due to dwindling fund sizes and poor returns. Prudential currently has its Income X fund, which gives exposure to the carry strategy, with an overlay of active management.
Bob Arends, Henderson's head of currency, says interest is keen among retail and private clients. The Luxembourg-domiciled fund has about US$72 million in assets. Mr Arends is described as a pioneer of currency alpha management. He started his career in 1996 with Shell's pension fund, and was responsible for its currency programme. He later joined Fortis Bank as global head of currency management.
'Pension funds want to have stable returns over time, a limited drawdown and good performance. Over time, the carry trade works very well, as there is a strong risk premium. But sometimes it doesn't work. We look for a way to be out of the market in extreme risk conditions.'
The fund seeks to mitigate risk in two main ways - diversification and downside protection. On the first point, the fund has substantial exposure, for instance, to emerging market currencies. In the last three years, the latter has generated double digit returns every year, he says.
Downside protection is achieved through a stop loss on all positions. He declined to specify the stop loss level. That currency markets are large, deep and liquid work in the fund's favour, he says, as it is relatively easy and efficient to enter and exit a trade, even at crisis moments. Investors, he says, appear to be warming to currency funds as an alternative to emerging market debt.
'Last year there was significant inflow into emerging debt, but the risk of (emerging market) debt is very high now. Most investors understand that inflation is picking up and EM rates will rise. That means you should not hold debt. We would argue that you should get out of EM debt.
'If you are bullish on emerging markets, you should be considering EM equities or currencies. Currencies do well when rates go up.'
The fund's engine seeks currencies with the highest carry on a risk-adjusted basis and a positive trend.
The more liquid G10 currencies comprise 70 per cent of the portfolio and emerging currencies 30 per cent. At the moment, the EM currency exposure is roughly 35 per cent. As a UCITS III structure, the fund can invest in forwards, swaps and other derivatives.
Absolute returns
This means that at any time a relatively small proportion of the fund's assets is invested in a trade. About 70 per cent of the fund is in liquid, short-term deposits. Leverage is, however, inherent in such contracts, and is capped at two times.
The fund is positioned as an absolute return vehicle, with a target return of 10 per cent. A performance fee of 20 per cent will apply to any excess return above a cash benchmark. There is a high water mark, which means the fund must exceed its previous high before the fee will kick in.
Bloomberg earlier reported that carry trades were profitable for most of the last three decades.
The strategy produced average annual returns of 21 per cent in the 1980s with no down years, and was the best of four commonly used strategies.
In the 1990s, carry trades suffered three down years including a 54 per cent loss in 1992. The strategy incurred losses three years in a row from 2006 to 2008.
This article was first published in The Business Times.
By Genevieve Cua
OVER THE LAST few years, currency has emerged as a big investment theme as the macro plays - a weak bias for the US dollar, a positive undertone for Asian currencies - have been strong and are often spoken of by strategists.
How can you benefit without actually trading currencies yourself?
Enter Henderson Global Investors with a new Global Currency Fund, a purely systematic or quantitative strategy that seeks exposure to currencies with the highest 'carry'.
The carry trade basically involves buying a higher yielding currency, using a low-yielding currency to fund the trade. The investor profits from the interest rate differential. There is, of course, currency risk in the trade. If the currency in which you are deposited in plunges, it could wipe out the rate differential.
Carry - the largest driver
There are roughly three drivers of currency returns over time - carry, momentum and valuation. Of these, carry has historically been the biggest source of return over the long term. But there are periods when it fares very poorly. 2008 was one such memorable rout. As risk aversion soared, the traditional carry trade reversed and caused huge losses as investors fled from higher yielding currencies such as the Australian dollar, and piled into the US dollar.
Singapore, incidentally, has seen less than a handful of dedicated currency funds. Two have actually closed in the last year or two, partly due to dwindling fund sizes and poor returns. Prudential currently has its Income X fund, which gives exposure to the carry strategy, with an overlay of active management.
Bob Arends, Henderson's head of currency, says interest is keen among retail and private clients. The Luxembourg-domiciled fund has about US$72 million in assets. Mr Arends is described as a pioneer of currency alpha management. He started his career in 1996 with Shell's pension fund, and was responsible for its currency programme. He later joined Fortis Bank as global head of currency management.
'Pension funds want to have stable returns over time, a limited drawdown and good performance. Over time, the carry trade works very well, as there is a strong risk premium. But sometimes it doesn't work. We look for a way to be out of the market in extreme risk conditions.'
The fund seeks to mitigate risk in two main ways - diversification and downside protection. On the first point, the fund has substantial exposure, for instance, to emerging market currencies. In the last three years, the latter has generated double digit returns every year, he says.
Downside protection is achieved through a stop loss on all positions. He declined to specify the stop loss level. That currency markets are large, deep and liquid work in the fund's favour, he says, as it is relatively easy and efficient to enter and exit a trade, even at crisis moments. Investors, he says, appear to be warming to currency funds as an alternative to emerging market debt.
'Last year there was significant inflow into emerging debt, but the risk of (emerging market) debt is very high now. Most investors understand that inflation is picking up and EM rates will rise. That means you should not hold debt. We would argue that you should get out of EM debt.
'If you are bullish on emerging markets, you should be considering EM equities or currencies. Currencies do well when rates go up.'
The fund's engine seeks currencies with the highest carry on a risk-adjusted basis and a positive trend.
The more liquid G10 currencies comprise 70 per cent of the portfolio and emerging currencies 30 per cent. At the moment, the EM currency exposure is roughly 35 per cent. As a UCITS III structure, the fund can invest in forwards, swaps and other derivatives.
Absolute returns
This means that at any time a relatively small proportion of the fund's assets is invested in a trade. About 70 per cent of the fund is in liquid, short-term deposits. Leverage is, however, inherent in such contracts, and is capped at two times.
The fund is positioned as an absolute return vehicle, with a target return of 10 per cent. A performance fee of 20 per cent will apply to any excess return above a cash benchmark. There is a high water mark, which means the fund must exceed its previous high before the fee will kick in.
Bloomberg earlier reported that carry trades were profitable for most of the last three decades.
The strategy produced average annual returns of 21 per cent in the 1980s with no down years, and was the best of four commonly used strategies.
In the 1990s, carry trades suffered three down years including a 54 per cent loss in 1992. The strategy incurred losses three years in a row from 2006 to 2008.
This article was first published in The Business Times.
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