Although FX as an asset class still offers potential for returns, asset managers are increasingly reluctant to allocate funds towards trading strategies that are only focused on FX trading, said speakers at the annual Profit & Loss Forex Network New York event.
On a panel session looking at allocation trends, the moderator observed that the speakers had avoided talking about ‘global macro’ or ‘FX’ strategies during the discussion, prompting the questions: “Is the phrase ‘I’m a foreign exchange-focused manager’ or ‘I’m a global macro manager’ out of favour still? Is FX a four-letter word?”
One speaker from an asset management firm said that they think that FX is still an exciting sandbox to play in because there’s so many different potential trading opportunities available within this asset class, adding that they think there’s still plenty of opportunities to generate alpha within the global macro universe, which they generally think about as being focused on rates and currencies.
They said that although some people have been disappointed at how gamma and short-term volatility has been so low in currencies and rates, there are pockets of liquidity gaps and disconnects that offer trading opportunities. In particular, the asset manager pointed to the USD/JPY move at the start of the year as an example of this, stating that we’re living in a world where these types events will continue to occur and therefore looks to allocate to funds that are able to effectively capture these moves.
Looking for consistency
Following on from this, Arvin Soh, until recently a portfolio manager at GAM Investments, said that in the past, his clients would have been happy for him to allocate funds to a manager only trading FX on the basis that it would offer diversification to the portfolio and is non-correlated to equities. Although it might mean the volatility would be a little higher and the Sharpe Ratio a little lower, logic would have suggested that this manager would be additive to the overall portfolio.
However, he then added: “I would say that’s not where our clients are now. Our clients want consistency, and consistency tends to imply diversification. So it’s very difficult for us to invest in a manager that only does FX, or only does commodities for that matter, because our clients want us to have that broader diversification. And it makes complete sense from their standpoint – they don’t want to have to tolerate a 15% drawdown and so if they can get the same returns without having to do so, then they will. I think that definitely makes it more difficult to be an FX-only manager now versus a few years ago.”
“I would say that there is still interest in newer managers and smaller managers, but they have to be really different”
Speaking of returns, the asset manager said although they would always prefer to see the macro managers that they allocate funds to generate more profits, the main reason why they hire these managers is because they expect them to know when to be long beta and short beta. This is effectively, they said, the alpha that these managers offer via their active trading. The asset manager also revealed that the firm has weighted its allocations much more towards discretionary macro strategies rather than CTAs for a number of reasons, the most obvious one being that the average CTA trades with double the volatility and half of the Sharpe Ratio of the average macro trader, because the former is typically using a systematic and more passive strategy.
The role of CTAs
This prompted a discussion about the role of CTAs within investors’ portfolios, with the moderator pointing out that the last time that this category of funds broadly produced good returns was 2014 and that, although uncorrelated to the stock market, they didn’t perform particularly well in December 2018 when there were drops – although brief – in the equity markets.
In response to this, Mike Dever, CEO of Brandywine Asset Management, a CTA that has been in business since 1982, said that he’s seeing an increased interest in crisis alpha-type strategies from investors.
“I can give you two examples of this right now,” he added. “One is an investor family office that made money through an investor company that owned and then sold. They’ve been hedging their own long equity exposure and they kind of converted that into with options and then they’re looking for us to create something using futures strategies that – although not a perfect hedge – is likely to give them better protection in a down market. So it’s like a trend following type of a scenario, but there’s a pretty decent probability that it’s not going to be losing money like an options hedge is for them during the up market environment.”
Dever continued: “The second example was an investment for a wealth manager who had a lot of clients that began getting nervous after their equity positions lost money in downturn last year. Brief as this downturn was, they’ve just been so used to making money. So we’re telling them to identify the clients that are most at risk, the ones that are most vocal and nervous right now, and we’ll sit down with them to create some sort of hedged-type product that will make these clients more comfortable maintaining their positions. This is a portable alpha type strategy whereby they don’t have to give up what they’re doing, but they get exposure to something that may provide negatively correlated returns.”
Investors getting nervous
The asset manager agreed that some investors are getting nervous, stating that there’s a growing concern that after 10 years of quantitative easing, of easy money, low rates and this massive rally in equity markets, there is too much equity beta in many portfolios. They predicted that there will be more volatility coming at some point, and not just in equities but across rates and currencies too, and that is why there is broadly an increasing inclination amongst asset managers to look at more volatility-friendly strategies.
“If you’re a CTA only trading FX with a time horizon of one to two months, you’re going to have a hard time”
Indeed, the asset manager said that their firm is embracing this possibility by reducing its equity beta and shifting towards more positively convex strategies such as global macro or quant strategies.
Likewise, Soh said that GAM Investments has also moved away from strategies with more beta, particularly equity and credit beta, since the beginning of 2018.
“We used to have maybe 30-40% of our investments in those areas and it’s basically halved since then. Part of this has gone to macro strategies, some of it has gone to systematic strategies, some of it into just more market neutral strategies and then a little bit more into vol strategies. We’re not trying to make a market call, or at least let’s say a directional call, but we do think that it appears that there’s more opportunities outside of equities,” he said.
Small funds need to differentiate
Another key talking point on the panel was the extent to which size dictates allocation decisions, with the moderator questioning whether there is a significant appetite to allocate to smaller funds given that there appears to be growing cost overheads for trading in today’s financial markets.
“I would say that there is still interest in newer managers and smaller managers, but they have to be really different,” responded Soh. “If you’re a CTA only trading FX with a time horizon of one to two months, you’re going to have a hard time. It’s not that there isn’t a price for this, it’s just such a low price that it probably isn’t worth it for the manager. But if you’re doing something very different, and crucially if you’re good at it, then there is an argument for investing in these funds. We do still invest in managers that have around $10 million in assets, but I would say that the hurdles for these smaller managers to get investment is higher now.”
The asset manager agreed that it has become harder for smaller fund managers to attract investment, but noted that the degree of difficulty can often vary based on what strategies a particular manager is employing for what objectives. For example, they said that it is challenging for funds using quant strategies to compete with the technological spend available to the incumbent players in the market and therefore the failure rate for these new funds is higher than average and as such, the hurdles to getting investment can be higher.