Why You Should Have Currency Management in Your Portfolio

The currency market is unique among investment markets in that most currency market
participants transact for reasons other than to make money. International equity managers buy
and sell currencies to facilitate transactions in stocks. Corporations buy and sell currencies to
facilitate import and export transactions and to hedge out unwanted risks. Central banks transact
in currencies to achieve policy objectives such as smoothing out unwanted fluctuations in
exchange rates. These three large groups of market participants are all 'nonprofit seekers' in the
sense that they will tend to go ahead with their transactions regardless of whether or not they like
the exchange rate on offer.
In a report produced by !eutsche "ank in #$$%& they estimate that nearly threequarters of
currency market flows derive from these nonprofit seekers. 'hat is interesting is that all three of
these large groups of participants in currency markets tend to lose money on their currency
positions on average over time. (s a result of this inefficiency within the currency market& alpha
opportunities exist for skilled currency managers to add value to your existing investment
portfolio. (dvantages in currency management include)
*onprofit seeking participants.
+inimal capital requirements.
,ow transaction costs.
!eep and liquid market.
#-./ global market.
012#.3 trillion daily volume.
*ot only does an investment opportunity exist in the currency market& but empirical evidence has
suggested that active currency management generated positive riskadjusted return over the long
term. Investing directly in currency managers is the simplest way to access these currency
market returns& as there is no need to develop your own currency expertise and trade your views.
The 4arker 56 Index& which tracks the leading currency strategies around the globe& has
increased 7$fold over the last two decades& while the !ow 8ones increased only fivefold over
the same period. 5urthermore& the correlation between the 4arker 56 index and equity&
commodity and bond indices is less than 7$9.
Balancing Profit and Loss
International equity managers who are successful in making money for their clients by tilting their
portfolios towards the best performing equity markets actually tend to give back around a
percentage of the gains that they make on their equity market positions in the form of losses on
the currency positions. The reason for this is that those countries with the best performing equity
markets tend to have the weakest currencies and vice versa. This fact may not seem to make
sense but just think about what happens to the share price of exporters whose currency is
appreciating& it comes under pressure as investors expect their competitive position to be
squee:ed. Consequently& if a central bank suddenly reduces rates it is the equity market that
receives a boost while its currency comes under immediate pressure. Therefore& to fully optimise
your equity and bond portfolio& it is necessary to manage the currency risk.