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Innovative Ideas in Currency Management October 2005. Evolution of Currency Management. Currency mandates Hedging (late 1980s; mid 1990s); Pure alpha (late 1990s; current) Absolute return (early 2000s) Cash play – use innovative FX programs to fill cash flow gap Currency managers
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Innovative Ideas in Currency Management October 2005
Evolution of Currency Management • Currency mandates • Hedging (late 1980s; mid 1990s); Pure alpha (late 1990s; current) • Absolute return (early 2000s) • Cash play – use innovative FX programs to fill cash flow gap • Currency managers • Single style using only forwards in EAFE markets (to late 1990s) • Multi-style using forwards, options, developed and emerging • Currency clients • Passive benchmark to managing their own strategic currency risk
Philosophy: An Untapped Alpha Opportunity! Corporate Treasurers (Insure foreign profits) Central Banks (Increase employment, lower inflation) Currency Market International Bond and Equity Managers (Need to buy currency to buy foreign assets) Individuals (Tourism) Many participants have non-profit motives
Impact of Diversification – Opportunities and Markets Cannot use overlay models/approach in this absolute return paradigm
Market Inefficiency = Simple Rules Make Money • Three simple rules make money in currencies. • Currency markets trend. • Buy the currency that went up last month. • Currencies with high interest rates will appreciate • vs. currencies with low interest rates. • Buy high interest rate currencies. • Options tend to be overpriced. • Sell options.
Performance of JPY Rules/Strategies • Rules Evaluated: (a) yield curve; (b) carry; (c) moving average • USD/JPY Strategy = 40% Yield curve and Carry, 20% MA • Diversification improves information ratio, skill, & drawdown Annualized Strategy/ Annualized Std Information Cumulative Confidence Success Ratio Good Max Rules Return Deviation Ratio Return in Skill Ratio /Bad Risk Drawdown USD/JPY 4.59% 8.56% 0.5365 57.45% 94.17% 52.86% 0.9103 -20.45% Strategy USD/JPY 4.54% 11.59% 0.3919 56.68% 85.59% 53.43% 0.8564 -26.21% Yield Curve USD/JPY 4.33% 11.59% 0.3741 53.57% 84.26% 52.37% 0.8613 -26.21% Carry USD/JPY 3.62% 11.59% 0.3121 43.22% 79.05% 51.12% 1.06 -20.51% MA 20-65 Source: AlphaEngineTM, Mcube Investment Technologies, LLC www.mcubeit.com (purely hypothetical example for educational purpose only)
Annualized Strategy/ Annualized Std Information Cumulative Confidence Success Ratio Good Max Rules Return Deviation Ratio Return in Skill Ratio /Bad Risk Drawdown USD/EUR 3.79% 5.09% 0.7444 45.69% 98.89% 55.21% 0.9793 -7.78% Strategy USD/EUR 5.20% 6.26% 0.8301 40.10% 98.42% 82.95% 0.8599 -8.08% Yield Curve USD/EUR 8.48% 9.71% 0.8729 127.66% 99.56% 55.21% 0.8997 -13.07% Carry USD/EUR -5.22% 9.72% -0.5372 -41.86% 3.13% 46.68% 1.1392 -49.12% MA 20-65 Performance of EUR Rules/Strategies • Rules Evaluated: (a) yield curve; (b) carry; (c) moving average • USD/EUR Strategy = 40% Yield curve and Carry, 20% MA • Trend model losses are meaningful; but moderate lower drawdown and worst single performance of the strategy Source: AlphaEngineTM, Mcube Investment Technologies, LLC www.mcubeit.com (purely hypothetical example for educational purpose only)
Fully Hedge % of Exposure Hedged Growth of a dollar from hedges Partially Hedge Do Nothing Return calculated versus a 0% hedged position
Innovative Approaches for Clients • Can generate meaningful cash, without funding, and with a specific dollar loss limit (easiest constraint to monitor) • Can be delivered through a managed account or even total return swap • Clients can also manage their own strategic decisions – biggest impact on performance • Trend to move away from traditional approaches and markets
