Currency funds see losses on lack of trends

FX Concepts, the world's largest currency hedge fund, says it lost 5.4 per cent in this year's first five months. John W Henry & Co's foreign-exchange fund told investors it lost two per cent, after 2008's 76 per cent gain, the best since its 1986 launching.

Both use computer models to spot currency trends and, along with other momentum chasers, are getting hammered by this year's lack of clear direction as the markets are pulled in opposing directions. Deflationary pressure from the first global recession since World War II is being countered by the inflationary forces of record stimulus spending and currency printing across the globe.

The ICE's Dollar Index shows the United States currency fell 1.4 per cent against a basket of six major currencies in this year's first half, the smallest two-quarter change since 2006. Of four currency trading styles simulated by Royal Bank of Scotland Group indexes, trend-following is the year's only loser, down 4.8 per cent after also underperforming in June. In 2008, the tactic gained 9.9 per cent its best in five years.

"I am not trying to make any excuse, but it has been difficult," said John Taylor, chairman of New York-based FX Concepts, which manages about $12 billion (Dh44bn). "Unfortunately, there's lack of consistency of what's happening. I am wondering how stupid the market can be for how long."

Deutsche Bank, which Euromoney Institutional Investor Plc ranks as last year's biggest foreign-exchange trader, predicted in April that "extremely weak trends" among Group of 10 currencies in the previous six months "augurs strong trends in the coming six months."

Yet the RBS's trend index's 11.3 per cent gain the following month, its best on record, was followed by a 1.3 per cent drop in June. The Dollar Index – which tracks the greenback against euros, yen, pounds, Canadian dollars, Swedish krona and Swiss francs – has traded within three per cent of its June 5 level for the past four weeks, the smallest such variation since July 2008. It rallied eight per cent in the first two months, only to decline nine per cent in the past four.

So-called implied volatility on options for major exchange rates is down by half from the record 26.55 per cent level it reached on October 24, according to data compiled by New York-based JPMorgan Chase.


Losing Streak

The currency fund of John W Henry, founded by and named for the owner of the Boston Red Sox baseball team, had a three-year losing streak from 2005 to 2007 as currency volatility dropped to record lows, leaving little room to profit from moves up or down.

It roared back last year along with volatility, gaining 33 per cent in October by betting on the dollar and the yen strengthening as the US mortgage market meltdown prompted traders to abandon higher-risk assets and pay back loans taken out in the two currencies.

This year, as last year's trend evaporated and volatility plummeted, the fund lost money in the first three months, dropping 3.8 per cent in March, its biggest decline since April 2008, the firm's website says. It gained an estimated 3.6 per cent in May by betting against the dollar, which lost 6.6 per cent that month against the euro.

"The positive returns may mark an end to the corrective phase of our programs performance cycle," wrote Kenneth Webster, the Boca Raton, Florida, company's president and chief operating officer, in his May results letter to investors. "Whether the movements of May signal the start of another run of good performance based on new trends remains to be seen."


No Certainty

FX Concepts' Global Currency Program returned 11.5 per cent last year, after gaining 11.9 per cent in 2007 and 18.7 per cent in 2006, according to Barclay Hedge, a Fairfield, Iowa-based firm that tracks and invests in hedge funds. The last time FX Concepts lost money was in 2004, when it fell 1.8 per cent.

"There's still no certainty," said FX Concepts' Taylor, who is betting on the dollar will appreciate. "I feel like I have a very good idea of what's going to happen. So far it's not happening."

The global economy will contract 2.9 per cent this year, the World Bank forecast on June 22, compared with a previous estimate of a 1.7 per cent decline. The US unemployment rate is likely to rise 9.7 per cent next year, the highest since 1983, according to the median forecast of 60 economists surveyed by Bloomberg. To end the recession, the US Federal Reserve has more than doubled its balance sheet to about $2 trillion in the past year, stoking inflation concerns.

"History shows that the best reward-to-risk trades are in the direction of the long-term secular trend," said Fall River Capital in its website's May performance note. "The recent rash of government intervention has made trading with this trend a frustrating task as the very rationale for intervention is to reverse the prevailing trend of a market."

Fall River, which manages $300 million from Mequon, Wisconsin, recorded losses this year through May ranging from 0.28 per cent to 4.8 per cent in the currency sector of its four trading programs. It lost money betting on the franc's rise after the Swiss National Bank intervened to weaken it and "caught us on the wrong side," the company said.


Short-term Strategies

Not all currency investors are doing badly. Half of 54 currency funds tracked by Deutsche Bank have made money this year, down from 32 of 51 in 2008, said Torquil Wheatley, a manager for the bank in London.

Among this year's winners are "high-frequency" traders who make hundreds of transactions a day to exploit "micro trends," he said. "Long-term momentum strategies have lost money since the beginning of the year. The really short-term trend followers have done well. They've dominated the year."

Frank Pusateri, president of Adirondack Portfolio Management, a New York consulting firm, said that "trading a time frame beyond a week or two" is problematic this year. "You've been getting strong moves in one direction for one, or two, or three days and then they have been chopping back at you real quickly," he said.

In this environment, humans are beating computers, according to Parker Global Strategies, which tracks about 60 currency funds with $29bn in combined assets. Discretionary traders, who usually base decisions on economic data, were up 0.92 per cent in this year's first five months, while funds reliant on mathematical models lost 0.28 per cent, the Stamford, Connecticut, company said.

Quantitative approaches based on historic trends will continue to struggle, said Richard Benson, who oversees $14bn of currency funds at Millennium Asset Management in London. "Past is definitely not the guide to the future because we've never been through an environment like this of huge fiscal stimulus," he said.

Decisions by central banks around the world to lower benchmark interest rates have contributed to lackluster performance, said Roddy Macpherson, investment director in Edinburgh at Scottish Widows Investment Partnership, which manages about £77bn (Dh454bn). Rates are at one per cent or less in the US, the United Kingdom, Japan and the 16-nation eurozone.

"Rate differential is moving sideways, and you cannot spot a trend," he said. "When you have rates being capped, it's difficult for these things to break out."

The currency market's relatively small moves may also be hurting US commercial banks that execute transactions for traders and make money on the difference between buy and sell prices.

Banks' revenue from foreign-exchange trading slid 40 per cent to $2.4bn in the first quarter after rising every quarter last year and reaching consecutive record levels in the final two, data from the US Comptroller of the Currency show.

Benson said currency managers' performance may improve as recovering economies diverge, with China, Brazil and other emerging economies better able to generate domestic growth than the US, Europe and Japan. "Currencies are very attractive as an asset class," Benson said. "Now we are at good levels especially for discretionary fund mangers to take risk."

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