| Currency Management 101 |
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| 26/09/2004 | |
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CSAM's Thanos Papasavvas answers this week's 101 on currency management 1-What is currency management? Currency management has two roles. The first is to manage risk by identifying the currency exposures of the underlying assets held in a portfolio - be it equity or fixed income risk - and make sure that the risk of the currency deviations against a given benchmark are in line with the philosophy of that fund. The second role is to use currency management as an alternative asset class to add excess performance (alpha) to the account. Due to the uncorrelated returns of currencies it may add some diversification to allocate some risk away from the other asset classes into currencies. The added benefit of currency management is that due to its overlay capability it does not require an allocation of capital from the existing asset-mix. With the emerging demand of alternative investments and the uncorrelated returns of currencies this has been applied across a range of funds varying from conservative cash accounts to currency hedge funds. This traditional role of currency management, however, is more cyclical in nature with demand (and therefore allocated risk) tending to increase when currencies add alpha (like in 2002 and 2003) but decrease as performance turns negative (as in 2000 as well as so far in 2004). 2-What kind of institutional investors is it designed for? It is designed for all types of investors. Our clients vary from conservative cash management mandates with tight risk/return profiles to government agencies, pension funds, mutual funds and total return funds. In our view, currency management will be increasing in importance as a more efficient way of managing portfolios. Using the roles of currency management, 'risk management' and 'alpha generation' means that there will always be interest in currencies, even in difficult markets. 3-Given the current market environment and economic outlook, how do you manage currencies at CSAM? Fixed income fund managers have always been aware of currency risk and have decided either to hedge everything to base currency thus eliminating any risk (as well as potential return) or to use them as another tool to add value. Equity fund managers, however, seldom cared about currency risk and kept equity investments unhedged, blasé about an extra few basis points when the overall portfolio returns were into double digits. What changed? The equity bubble burst, and with negative performance equity fund managers tried to salvage any basis points they could through a more astute policy on currency management. It was a 'risk limitation' strategy that brought currencies closer to equity fund managers, as well as the ad hoc opportunity to use currencies as an extra source of adding alpha. In CSAM we analyse currencies in a functional rather than the more traditional geographic way. We have identified five factors that drive currency markets over our three-month time horizon, some fundamental and some behavioural, and also have a standalone Bayesian quantitative model. |
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Articles of the same Serie : 101 |
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Articles of the same Topic : Currencies |
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