There are multiple drivers of currency and investors have failed to understand that these are far more complex than just momentum and carry and change over time.
This is the view of Andrew Harrex, managing director, Australia/New Zealand at P/E Investments who as a panelist at Investment Magazine’s Fixed Income and Credit Forum, listed a number of different factor drivers – or currency regimes – that drove currency markets during the Brexit negotiations, the global financial crisis, the Greek crisis, the Mexican crisis and the tech bubble of 2000.
His research into the factor drivers behind these currency movements highlighted that different factor drivers drive currency at different times.
“For each time period, there seems to be one main factor driving the returns on currency,” he said. “In one instance the driving factor was carry, another inflation, and yet another economic momentum.
“So, the traditional approach of purchasing power parity doesn’t hold all the time… the chart show that different factors are driving currency returns throughout the economic cycle.”
Harrex said that generally speaking, active management has been successful – although the results might indicate some survival bias as the number of fund managers has been dramatically reduced. According to a bFinance paper the majority of active managers successfully add value, with 58 per cent adding more than 1 per cent per annum over the past five years. Further, the majority of returns had a low or negative correlation with equities.
Justin Lo, investment manager, fixed income and currency at Sunsuper, agreed that an active portfolio was a necessary diversifier. “When we talk about a passive or active overlay program, we have to think of the operational efficiency of the program especially in this environment,” he said.
“Active managers are a pretty cheap insurance policy,” Lo noted adding that with a passive program, understanding the total cost structure was paramount with external managers. He said that it’s not just the management fee but the transaction fees, having a full grasp of the market risk, as well as transparency and access to reasonable pricing from the bank. “All of these should be considered in proving the total outcome,” he added.
The three panelists, which also included Ben Ereira, director at Cerca FX Consulting, debated whether the dynamic active approach was alpha generating or risk mitigation.
Ereira said the two objectives should be broken up into separate components as that mentally worked well.
The consultant also keyed up the importance of trying to generate implementation alpha through operational efficiency.