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(Bloomberg Businessweek) — Currency-only hedge funds were once a hot corner of the investment world. From 2000 to 2008 the tally of currency funds tracked by the BarclayHedge Currency Traders Index almost tripled, to 145. Now they’re looking more like an endangered species, with just 49 in operation.
Managers who try to play trends in foreign-exchange rates—swapping dollars for pesos or euros for yen—have been victims of a long run of relative calm in financial markets. “In traditional asset classes, volatility is a bad thing,” says Peter Jacobson, co-founder of Rhicon Currency Management Pte. Not so in currency. If not much is changing in the relative fortunes of different countries, and in the value of their currencies, there are fewer ways to profit.
In the years since the financial crisis, major central banks around the world have all pulled in more or less the same direction: holding down interest rates, encouraging growth, and trying to keep markets calm. This hasn’t given traders much to work with. Volatility in currency markets took a fresh dive starting in late March. The J.P. Morgan Global FX Volatility Index sank to its lowest level in five years as traders coalesced around the view that the U.S. Federal Reserve and its counterparts will extend their quantitative-easing measures.
“The way most people make money in a foreign-exchange fund is to expect that, in fact, the market is going to move away from quietness to activity, and of course the Fed wants it to go back to quiet,” says John Taylor, who runs Taylor Global Vision, which produces a newsletter on financial markets. “Before the flame starts, they snuff it out.” Taylor speaks from hard experience. FX Concepts LLC, which he founded in 1981, was once the world’s largest currency hedge fund, with about $14 billion under management at its peak in 2008. But after years of losses for the fund, its parent company filed for bankruptcy in 2013.
The good old days for currency hedge funds were tough times for everyone else: during the throes of the Great Recession, when stock markets crumbled and markets were in disarray. The Citi Parker Global Currency Manager Index earned about 8 percent from 2007 through 2009, but the S&P 500 lost about 16 percent in that period.
The recent spike in stock market volatility in late 2018 didn’t give currency funds much of a boost. Jacobson’s Rhicon shut down the bulk of its trading positions in October as classic havens, such as the yen, failed to respond to gyrations in equity markets. While the fund still isn’t at typical trading levels now, Jacobson, who splits his time between Singapore and Sydney, remains optimistic that currency trading will prove its worth. Central bankers are talking about risks to growth ahead, and prices in the bond market seem to be giving the same warning. “Given the late stage of the economic cycle, I would say that it is a good time to start looking at currencies,” he says.
Jacobson may still have a hard time convincing the likes of Aberdeen Standard Investments, which invests in hedge funds. It’s steering clear of “pure-play” currency funds, says investment manager John Sedlack III, in favor of those that can invest in a variety of different assets to take advantage of big-picture trends. “We prefer managers that have the flexibility to find the asset class that is most mispriced,” Sedlack says.
The grim outlook has James Wood-Collins at Record Currency Management Ltd. considering branching out to other asset classes. Assets in the firm’s active currency strategy have declined to $3.6 billion, from about $29 billion in 2008. “We are certainly well aware of the opportunities for similar investing styles outside of currencies,” says Wood-Collins, the London-based fund’s chief executive officer. “We definitely wouldn’t rule it out.”
One move that’s worked lately is to wager that the FX market, as traders call it, will just stay boring. Among 2018’s standouts was LCJ Investments SA; the Geneva-based firm returned more than 4 percent last year, compared with a 3.4 percent loss for the Citi Parker index. In addition to directional bets, the fund also employs options contracts to wager that exchange rates will stay in specified ranges. “Volatility is down across many markets as well as FX,” says co-founder Jonathan Tullett. “The post-crisis, QE world changed many of the dynamics, but there are still investment opportunities in FX.” —With Liz Capo McCormick
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