Currency Management Strategies Algoam ALGOAM Foreign exchange market, with its deep liquidity and currency pair dynamics – which is very different from other asset classes – can help in developing strategies that offer strong diversification to a portfolio of strategies. Currency Market Dynamics Currencies are a proxy for a range of asset classes. The credit worthiness of countries is reflected in the relative value of each country’s currency. Currency value reflects the absolute level of real interest rates as well as the direction of the overall economy and geopolitical risks which impact economic outcomes. Mismanagement of any economic system very quickly gets discounted in the currency markets. Currencies can thus be used as an alternative asset class to equities and government bonds, both as sources of short term returns as well as long term trends. However, one has to be take care and make sure that currency positions earn the local currency rates at close to local deposit rates or government bond yields for the period held. Currencies are relative value plays. Relative value is subject to many factors, fundamental as well as sentiment related. Currency values are impacted by both portfolio investments by foreign investors as well as speculation and Central Bank interventions. Central Banks intervene to manage currency sell offs as well as to prevent currencies appreciating too much. The tools Central banks use are direction intervention or through monetary policy actions, by reducing or increasing interest rates. Reducing the term structure of rates through asset purchases is a more recent, but now widely used tool. The daily price levels reflected in traded currency values is a result of the competing nature of all these forces. Currency Strategies in Portfolio Portfolio managers seeking greater diversification and another source of absolute returns are increasingly turning to currencies. Theory has it that diversification is a good thing. For long term passive portfolios diversifications reduces overall risks. Traditional views on market movements are based around the theory of uncertainty of future asset prices and in a diversified portfolio it is assumed that losses in one part are compensated by gains in another. We know from experience that economic trends caused by fundamental or economic mismanagement take time to unfold. The financial crisis lasted for years and as a consequence the EURO was in a downward trend for a very long time. The recent crisis in Russia has also spun out for more than 2 years and one can see that markets can reach extreme levels before stability returns. Leaving a diversified portfolio untouched can thus come at a great cost. Currency markets exhibit ample liquidity. The cost of portfolio adjustment is very small compared even with the daily price fluctuations. A dynamic approach to currency portfolios can be applied at low cost. Algoam Currency Strategies Algoam systematic currency models take emotions out of the investment process. Currency sentiments are captured in observed price movements. Rate direction and differences are monitored in real time as well as on a longer term basis. Proven techniques for capturing currency returns using technical signals, pattern recognition, multi-time frame analysis is implemented and automated directly onto trading platforms. Client assets can be managed in their accounts with real time reporting. Algoam models are designed to achieve different risk/return objectives and to solve different end goals such as yield enhancement, improve diversification of existing multi-asset portfolio and most important have the objective of achieving absolute returns. 1 Algoam Examples of Algoam currency strategies: FX MULTI-TIME FRAME STRATEGY http://www.algoam.com/strategies/ FX Multi Timeframe is an automated strategy which identifies swing based patterns to capture momentum. Signals are generated on three developed FX pairs – EURUSD, USDJPY, and AUDUSD. These patterns are developed on multiple timeframes with only one trade open at any point in time – each trade holds a leverage of 3x. Pattern timeframes are dynamic which keep changing from one entry to another. This strategy offers very low degree of optimisation – the choice of timeframe lengths is the only parameter used to enter a trade. Exits are allowed with static profit targets. Annualized Return Annualized Volatility Maximum Drawdown 33.24% 10.98% 8.01% Sharpe Ratio Ann. Return/Max. DD. % in Market 3.03 4.15 80.49% FX G10 CARRY STRATEGY http://www.algoam.com/strategies/ The FX G10 Carry Strategy aims to derive its returns from carry income of G10 currency pairs. Unlike other carry strategies which are constantly long the higher interest currencies; G10 carry takes long/short/hedged exposure based on expected return and carry income of the currency pairs. The performance of this strategy has been consistent with superior risk-adjusted returns. The returns below are without the use of leverage. Indeed the strategy can be more market neutral. Annualized Return Annualized Volatility Maximum Drawdown 9.97% 8.30% 10.83% Sharpe Ratio Ann. Return/Max. DD. % in Market 1.20 0.92 98.4% 2 Algoam The Right Time to Use Currency With interest rates and bond yields are extremely low levels, currencies are a good alternative for generating portfolio returns. Currency hedging is on the rise as central banks devalue their currencies, which then has the impact to increase asset prices. US investors, for example, have done much better when they have invested in Japanese equities but have sold the JPY forward. Competitive devaluations don’t create long term winners. Pricing wars, be they in currencies or commodities (Oil) lead to negative and positive consequences in different segments of the market. Movements in currency values far exceed rate differentials. These movements, triggered by perceptions on changes in rates, in intelligent models, with risk control, can be used to generate absolute returns. Conclusions We believe that currency management is emerging as an important asset class. Combined with bonds it becomes even more powerful. Added to traditional asset allocation portfolios, currencies add stability and uncorrelated returns. Institutions should consider including currencies to existing portfolios as well as an alternative asset class. 3
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