Business | Investment
Don't currency investors care much about losing money?
Investors are increasingly making up their mind and voting with their feet as they put money to work in the currency markets.
- By Steve Johnson, Financial Times
- Published: 00:00 October 10, 2009
Academics will probably always debate whether foreign exchange is a legitimate asset class. Investors are increasingly making up their mind and voting with their feet as they put money to work in the currency markets.
The foreign exchange market is the world's largest and most liquid, with $3.2 trillion (Dh11.76 trillion) being traded daily across the globe. Yet it is also a zero sum game; a gain for one participant must be matched with an equivalent loss by another.
In investment parlance it has a "beta", or expected market return, of zero. Skilled traders may — in theory — make repeatable returns but participants as a whole cannot.
In spite of this, a growing minority of institutional investors are moving beyond passive hedging of their underlying foreign exchange exposures — a tactic designed to prevent losses — and embracing active currency management as a source of potential investment returns.
Deutsche Bank, a leading player in the sector, estimates this pot of "alpha", or return-seeking money, at $30 billion, having seen the assets of its FXSelect platform of external managers jump from $1 billion at the start of 2008 to $3.5 billion now. Others believe the true figure is far higher.
Some six per cent of US institutions have adopted an active currency programme, according to research by Greenwich Associates. Calpers, the influential Californian public sector pension plan, has invested $100 million in a pilot scheme. In the UK, the National Association of Pension Funds found 12 per cent of its members had taken the plunge.
Cheerleaders
Cheerleaders for the foreign exchange market square the circle by arguing that, although the market as a whole is zero sum, many participants are not seeking to maximise profits.
A company needing to sell dollars and buy euros to facilitate a cross-border trade, or an investor needing yen to buy Japanese equities, is not seeking to make a profit on the trade, and will make transactions at pretty much any price, the argument goes.
"The market overall, by definition, is a zero sum game, but there are a lot of people who are not profit maximisers," says James Binny, head of index research at Royal Bank of Scotland.
In essence, while equity and bond markets have positive beta, the average manager produces no alpha and thus adds no value, although individual managers may do so. In contrast, while foreign exchange has no beta, it may be possible for the average fund manager to generate alpha.
Deutsche calculated that profit seekers were in the minority, a position the bank sticks to today. "It's 10-30 per cent speculators and 70-90 per cent people who don't really care about losing money on their currency trades," says Torquil Wheatley, head of currency solutions for pension funds and insurers.
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