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Currency funds suffered from the low volatility that defined 2012, but FX Concepts? new Chief Strategist
Bob Savage is cautiously optimistic that 2013?s start can be sustained as hot spots around the globe
promise to keep things interesting. P&L?s Julie Ros sat down with Savage for a macro view of the
markets, and a micro view of FX Concepts. 

Julie Ros: How is being integrated into FX Concepts?

Robert Savage: It’s a wholly owned subsidiary; it’s still a
standalone product. We’re taking what we’ve learned and are
applying it to FX Concepts’s own product. We are trying to see
what technology and ideas can help them and vice versa. That’s
the first move. The second move is from a personnel level. I’ve
taken on a larger role at FX Concepts as their chief strategist.
The role of a chief strategist at a fund is not about running
models, it’s about really guiding the business forward. So that’s
ultimately my vision, and [FX Concept’s CEO and founder] John
Taylor’s vision, which are being melded together to create a
vision of what FX Concepts is going to look like over the next
five to 10 years and what the game plan is for us to get there. I
want to grow FX Concepts to $10 billion under management in
FX and other assets classes – some in fixed income, some in
indices and equities and some in commodities. So when people
think about FX Concepts, it’s not just an organisation that looks
through the FX lens, but that lens is a useful one for looking at
the world of available, tradable, liquid products. If we’ve learned
anything in the last five years it’s that by me being pigeonholed
into FX only and when FX has 4% actualised vol, your returns
are going to be disappointing, so you’ve got to have something in
place to sustain that.

JR: Any new products in the pipeline?
RS: We’ve had a new product over last six months called Pure
Beta Plus, which is effectively a risk parity trade that has,
unlike our competitors, a very substantial FX component. So
we have bonds, FX, commodities and broad indices, but we’re
only trading liquid, positive carry vol weighted components –
so 25% goes into commodities, 25% of the risk goes into each
of these areas. That means you might actually have a very small 
amount of commodities in dollar terms because they’re more
volatile. It also might mean that you actually have a larger
percentage of bonds, because they’re less volatile, but over time
that will change, and we harvest the volatility of the market on
a daily basis. So as things move up and down, we are re-
weighting accordingly. It started last year and was on a runway
for 19% return, which gets people excited, but I think it shows
that you can take an FX lens and really get a broader
perspective on other markets. That’s what FX Concepts is all
about. Not that we’re going to lose our central mission or
central idea of our 31-year history of trading FX, we’re going
to be the best that we can in those models. But everybody
knows them – trend, carry, mean reversion, vol, we do them all
and were in the top three percentile in DB Select last year and
made a 1% return. That’s just not going to be exciting to all
investors, although some are going to see through that and say
‘These guys are experts in this and were up 1% when the
average fund was down 4-5%.’

JR: Since you joined FX Concepts, what has been the major change?
RS: Having done this before, you’ve got to learn about what you
have first, so there haven’t been any major changes. I’m not a big
advocate of rushing in to change a culture that I respect and
know has been around a long time. I have been spending the last
few months really learning what the strengths of the organisation
are and how to get the most out of it.
One thing I’m doing is trying to take the lessons that we’ve
learned over last three years about risk management and help
optimise that and make it much more algorithmic, and come up
with a way of tying more econometric fundamental ideas into
their process. That’s what John has always done. He’s a very 
thoughtful, cyclically attuned leader and I’m trying to take my
fundamental understanding of how the markets work and apply
that to models and help them think through which set of models
may perform better over others in certain circumstances. That’s
not so easy to do.

 JR: And it hasn’t been an easy time in the markets either…

RS: For all funds, this has been a difficult three years so we’re
trying to live within our means and make the right long-term
investments for growth, and in the short term, keep things as
tight as possible.

JR: What are the most interesting events on the horizon this year?
RS: The focus has shifted from European breakups, to the US
debt downgrade, to Japan and the yen debasement, and then
there’s the insipient global stall speed growth problem, which
begs the question of what is the correct balance of government
and private sector involvement in almost every aspect of the
economy? When you look at places like Europe, there are doubts
around whether Merkel is really going to have no problem
getting re-elected; is Italy really going to have a clear cut
majority in leading it and sustaining its fiscal austerity measures;
is Spain going to be able to grow as targeted enough to meet its
fiscal needs? The answers to those questions bring you back to
Europe as a risk. But this time, unlike the past two years when
everybody said Greece and Spain just have to leave the euro,
we’re now in a situation in which Germany is no longer able to
hold up the whole enterprise. So the euro actually becomes a
much more important tool for driving flows in and out of Europe.
There’s been a tremendous amount of bottom picking for
European equities, and I think there’s been a large scale 
reinvestment into some of the periphery bond markets. As soon
as that plays out and we get growth doubts again, you could see
another outflow of Europe if they disappoint on the growth
recovery front.

The arguments I’ve seen for Europe re-growing rest really on the
US and China. The biggest argument you hear for growth
coming back in Europe has been that it has been so bad that it
has got to get better, but I don’t find that persuasive. I also think
that the way the periphery of Europe handles this, how the
outsiders – the UK and how it tries to renegotiate terms with the
EU, the Swedes, Norwegians, Switzerland and how Poland and
Hungary and satellite states like the Ukraine – are all going to
interrelate. What’s the role of Serbia to Europe and how is it
going to be part of this union is a question that becomes more
complicated. While it was once going to be that all of Europe
would be trading euros one day as one big happy market, it’s no
longer that way and at the heart of it you’ve still not dealt with
the banking crisis. From an economics perspective, I look at
Europe and think, you have a credit crisis, you have not resolved
it, there’s a banking crisis behind this and there’s no shadow
banking way around it.

China has a shadow banking system that has allowed it to grow
at 7.5% – I don’t think it’s sustainable and think the biggest
risk for China revolves around that shadow banking system
looking strangely like ours did in 2007. When banks are full up,
the shadow banking system takes the credit job in tow and then
it blows up and you’re left with a pile of bad loans. Europe has
never dealt with those bad loans and the day of reckoning for
banks is still to come – the euro group has yet to come up with
a pan-European solution that’s believable to investors and that
is the problem with Europe. It’s painfully sad to see and it
becomes less and less important to investors over time, and it 
puts more pressure on places like Latin America and Africa.
The real problem for Europe is that it operates as a union of
convenience and without a unified Treasury, unified banking
system and a foreign policy, you’re prone to what’s going on in
North Africa. North Africa as a problem to Europe and the US is
clearly on the rise. If we learned anything about what’s going on
in Mali, it’s that the entire region’s exports to Europe for natural
gas, energy and oil are at risk and the political stability many
thought would come out of an Arab Spring revolution just smacks
of what happened to Russia. That region being destabilised is a
huge risk and the US pulling out of the Middle East leaves
Europe vulnerable. It’s a great chance for China to come in and
have a much bigger role there and I expect that to happen.

So for Europe, it has to deal with the fact that the Long-Term
Repo Programme (LTRO) is going to be a little bit unbalanced.
In the LTRP, banks can borrow up to three years for 1% and give
cigar wrappers and vodka bottles as collateral. It’s clear now that
they need $2 trillion, which was their version of QE – they did it
in a very bank centric way, which is dangerous to the balance
sheet of ECB, because it was left holding cigar wrappers and
vodka bottles as collateral. The real problem for Europe
therefore, is having a lot of back book positioning that has not
moved. Every bond fund able to get access to US paper in the
distressed debt area did so, none of it came from Europe and
that’s the problem, because they’ve got to get rid of that. That’s
my biggest worry.

JR: Looking at Asia, is Japan a major problem for the region?

RS: Japan is a problem for trade and for re-nationalising the
politics of that region. Countries like Thailand and the
Philippines are going to be forced to choose between China and
Japan, and Korea is being torn apart as well, so the currency
destabilisation is just a symptom of bigger problems of alliances
and the removal of US leadership. Basically, the implicit
guarantee that the US was going to be the arbiter of all things
trade and leadership in the region have fallen down; it’s not
credible for the US to say to Taiwan we’re going to protect you if
China is going to invade, not that they would because they’ve
already effectively made plans that Taiwan will be like Hong
Kong and the Taiwanese are beginning to believe that.

JR: What are the implications for the region of that slow

RS: It will come to a head in places like Myanmar. The question
becomes, who is really going to benefit from those untapped
resources? What’s really going to happen in North Korea when it
begins to become like Eastern Germany? Who’s going to be on
the winning side of that?

JR: What themes are you tracking in Latin America?
RS: The currency wars is still a theme, because the money is
flowing into the region due to its demographic, economic and
export mix of commodities and other cheap goods. So the
Americas are in a great position. These nations are also largely
politically stable – there hasn’t been any real political uproar, and
even if there is uproar, such as in Venezuela, it’s not necessarily
bad uproar. The question is what to do with this inflow of
money: do you just intervene and build up a currency fund; do
you lower rates; or do you put up Brazilian-like walls? All of
these can lead to unintended, insipient, inflationary risk.

JR: Do you think Latin America is on the edge of an
inflationary spike?

RS: Yes, and whether the central banks are up to the task of
responding to it is the big question. Also, whether there is
enough inter-regional trade between Brazil and Mexico as a

goalpost to getting off the dependency of being on the dollar or
euro or yen rollercoaster. There is also the question of whether a
currency union in Latin America would help respond to the
inflow and whether there’s a need for supra-regional leadership.

JR: Is the region’s dependency on commodities a risk in 2013?

RS: If we see China simply need less and if we find that certain
of China’s trading partners have overbuilt capacity to deliver
these commodities to China, there is a question about what that
means for the region. It remains to be seen if the region can
thrive with Brazil being lacklustre.

JR: So China’s performance will be key?
RS: China targeted 7-7.5%, so everyone’s excited about a bounce
in Chinese demand. But, if the authorities are telling you they’re
happy with 7.5%, that’s a problem, because that means you could
have 7%. Countries like Brazil have built out their export machine
for iron ore, oil and food for an 8-9% Chinese growth rate. If it’s
really going to be 6.5-7% over the next five years, that’s a
problem. You could also throw in the other part, which is that
increasingly, people are concerned about global warming and
what it means for their export base. Is there a risk that these
weather conditions we’re seeing in the region are permanent and
if so, what does that mean in terms of who the winners and losers
are? Also, do they have any real environmental programmes?
Brazil clear cut the Amazon and now, the ability for them to
sustain their agricultural predominance is actually limited because
they don’t have any sustainable policies in place. Is that a lesson
for the rest of the region? It is particularly in places like
Guatemala and Honduras, which incidentally, is where most of
our food comes from. These guys are not necessarily following
any better sets of rules for sustainable agricultural output.

JR: Ten years ago, Latin America mainly faced Europe, but
now it largely faces Asia. Is there a chance for Europe to
regain its position?

RS: There could be an opportunity for growth in Latin and South
America in re-facing Europe, but the region as a whole is very
mixed on how it faces Europe. For example, the
Argentina/Repsol fiasco represents a nationalist mentality that
can be an impediment to new capital flows and believability.

JR: I get the sense that a lot of the world is going nationalistic.
What is your view on the very divided US Congress?

RS: The belief in the common wealth – as opposed to private
wealth – has been lost. We have such great national traditions
and things we should be proud of; namely, that we can peaceably
have an election and give a person the reins every four years and
celebrate as a country that democracy works. But what’s
happened in last 16 years is that we are no longer participating in
the things that make us great as a nation.

JR: What are the implications?
RS: We only believe in the nation when the policies suit us. That’s
really unhealthy, selfish thinking that loses the greater good; which
goes back to the common wealth ideal. There are things that we
need as a country that all of us benefit from – the military is
obviously one of those and infrastructure such as highways, ports,
trains, help us all. Infrastructure is something Latin America has
no problem thinking about and putting money into. As for the
infrastructure in the US, we need $3-4 trillion just to sustain the
roads and bridges. Anyone who lives here sees it. It’s obvious.

JR: Are there any bright spots?
RS: The US remains a very vibrant and dynamic economy and
despite the worst political stalemates and debt problems, we’re 
growing and we’re coming out of it. While we may still see some
cyclical downturns, our housing market is clearly in recovery
mode, our ability to grow is becoming more clear to people and I
don’t really think the politics will get in the way of the Fed’s
program from working. At worst we muddle through, at best, we
grow at 3% over the next two to three year horizon, so the US
has got a lot of things going for it. Not the least of which is
energy independence on the horizon and a clear cut technological
edge. We’re very quick adopters of new technology, and remain
willing and dynamic to confront our problems and deal with
them as needed.

JR: Anything positive for the year ahead?
RS: If I had a theme for 2013, it’s about the regionalisation of
the world and how you could invest on a region by region basis
and do well. The region of 2013 that seems best positioned is the
Americas, second is Asia – divided into North/South. We could
see Japan surprise us a bit if it comes out of its recession and the
devaluation of the yen, while China could disappoint a little.
Europe remains the weakest link, but it’s just less important. The
surprise could be that Italy, Spain, Greece, Portugal and Ireland
have taken enough medicine and actually stabilise and grow
better than the rest of Eurozone, but that’s about a 30% chance.
While European banks are pulling back their roles
internationally, there’s room for US banks to really have a
resurgence – especially in Asia. So US banks are going to
become more important.

JR: Given your views on Latin America, what are your views on
the future of the NDF market?

RS: Dodd-Frank really changes the way FX works for some
instruments. If NDFs are going to be regulated and need to go
to central clearing, that means transparency about what 
volumes are really going through. FX is the most opaque
market about volume and the most transparent about price. As
soon as you marry the two, it becomes a little bit more equity-
like so a lot of business models in FX are starting to shift from
fixed income-like ideas where price discovery matters to OTC
markets to exchange model markets, where access is provided
for a fee. If you add up all of the prime brokers’ business, all
the new agency FX brokers, all the exchanges, as well as the
algos being provided by banks, add in retail, and you’re talking
about 45% of the market.

JR: Do you see the flow in NDFs increasing?
RS: Yes, because it is business that has to be done.

JR: So you are bullish on EM?
RS: Yes, I think growth in FX rests with EM. If you look at the
revenue streams at banks, half of the money in 2011 came from
EM, and 2012 looks like it could be 55%. Volumes will
continue to go up. There’s going to be margin compression, but
some banks are going to specialise so we’ll see pockets of
banks do really well in Korea and Brazil, and others in say,
Indonesian rupiah.

JR: What about options?
RS: Options are a bit more of a problem. Options users
traditionally have been corporates and hedge funds, then a bit
of the sovereign wealth crowd. But the idea that a corporate
needs to use an object that’s expensive as opposed to using a
forward that is probably unregulated in a lot of currencies is
going to be a problem, or a future. The need for options in the
FX market is not growing, it’s stable. Options desks could be
replaced by structured desks, where you pay for the structure.
The options market may become more adept at being on the
futures market. You’re not going to have an exact match, but
enough liquidity will be there that you feel like you’re covered.
That’s a huge shift. Reinvention is key – innovation and
adapting to the new world.

JR: What about the electronification of this market?
RS: I think this has yet to be seen to its full extent. It will be
two or three years before you get the kind of transparency
that you would expect from the EBS-like model. Currently,
there are screens that show you where price is, but you don’t
know where it traded. Soon, it’s going to be completely

JR: What about G10?
RS: In terms of spot, we’re at absolute zero of spreads. The
surprise for FX is that, in the picture I painted of all these
problems, none are that material and we probably grow at 3-4%
per year for the next five years. But if FX grows at 10-15% per
year, nobody has the capacity in place to handle an $8
trillion/day market. That’s the real risk. World trade, which drives
all asset flows, just needs to go up and FX will follow. The
electronification of fixed income brings more volume, which
begets more volume for FX.
That said, we’re in for very tumultuous times. There’s been a
30% cyclical bull run in bonds – from the glory days of
Ronald Reagan in 1981 at 18% – down to 1.4% last summer.
What’s the next move? What happens to FX in the midst of
that is a significant opportunity over the next five years as the
market for bonds bottoms out. Five years from now, we’re
going up, and that’s volatility into FX, so I’m very optimistic
about being in this business over the longer haul. Right now,
not so fun, but so be it. 

Paul Gogliormella

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