Deutsche Bank has launched a set of indices that are designed to capture returns generated by the growing coordination of currency policy among Asian central banks.
The DB Asia Convergence Indices simulate a market neutral strategy that exploits what Deutsche Bank believes is an increase in correlation among local Asian currencies in up to 12 markets.
The trend is a result of the widespread use of trade-weighted currency baskets in the region, which Asian central banks appear to use to protect export competitiveness, says Deutsche Bank.
Martin Hohensee, head of fixed income and credit research in Asia at Deutsche Bank, says,“The concept of an Asian Monetary Union has been validated by a number of economic studies and is getting serious attention among central banks and exporter groups. While obstacles to a formal union remain, the underlying economic rationale seems to be affecting central bank behaviour in Asia. This creates opportunities that are similar to those presented in the early stages of Euro convergence.”
Deutsche Bank research suggests that widespread use of trade-weighted currency baskets has corresponded with an increase in the correlation between individual Asian exchange rates.
“As correlations increase, intra-regional carry trades become more attractive. With correlations between local Asian currencies nearly perfect, intra-regional carry trades can be more accurately labelled ‘convergence trades’, much like those done in Europe in the 1980s and 1990s during the early approach to European Monetary Union,” says Hohensee.
However, unlike the approach towards European Monetary Union, the current trend being seen in Asia is not driven by an explicit single policy. Rather, Asian currency policy is more informal and adaptive.
“Therefore the trading strategy needs to be adaptive, adjusting to changing patterns in currency volatility and correlation created by Asian central bank behaviour. This is the approach we have sought to embed in our indices,” says Hohensee.
Deutsche Bank has also launched two specific indices that allow investors to take a more focused view on the monetary union trend in Asian local currency markets.
The DB Asia Convergence Index – Narrow, gives exposure to potential returns generated by this trend in non-Japan Asia, while the DB Asia Convergence Index – Broad, gives exposure to the Narrow index plus Australia and Japan – the two markets which are likely to be most affected by Asia Monetary Union behaviour.
All indices can be accessed by buying a note that simply tracks either the indices; via standard options; by buying a note which pays LIBOR plus the performance of the indices; or via a CPPI structure, which provides managed exposure to the indices while providing principle protection.
“While we do not expect a monetary union to be implemented in Asia in the near future, the underlying economic rationale, we believe, is having a degree of influence on central bank behaviour in the region. This presents a compelling opportunity for institutional investors, who can use the DB Asia Convergence Indices to gain efficient access to this trend,” Hohensee says.