FX as Pure Management Alpha Assets for Fund Managers
Team Latte
Aug 01, 2005
FX - foreign exchange rates or currencies - are an integral part of all fund managers and corporate treasurers' portfolios. Traders and investors in FX exposures make large profits and losses every day and the market for derivatives on FX is simply humongous. However, can FX, like a commodity or equity or a bond be treated as an asset?
Ask this question to an FX options trader and he will say: "of course!" If we can trade options and swaps on FX, then it has to be an asset. Ask a fund manager or a corporate treasurer and he may say: "maybe". A fund manager may argue that the reason he is reluctant to consider FX as an asset is because:
- Capital per se is not required to take currency positions (as is required for taking positions in equity or bonds);
- Currency positions do not offer any intrinsic returns like other assets;
- There are no stable risk premiums.
Actually, currencies are defined as "tactical asset class", very different from "strategic asset" class which encompasses equities, bonds, real estate and commodities. Some fund managers also define FX as "pure management alpha" assets. We would like to stick to this definition as opposed to the former one (though both can be used interchangeably).
Pure management alpha assets exhibit three attributes:
- They have low correlation with strategic assets such as bonds and equities;
- They almost always have positive projected return;
- No (or very low) actual capital is required to initiate a position in these assets.
In fact, the above three attributes exemplify why it is a pure management alpha asset. An FX position (as a part of a strategic asset trade) increases the alpha of a trade, though there is no certainty, even with any superior knowledge about its direction, of capturing any return within the FX position at all.
However, also, because of the correlation attribute and because of the volatility of the FX position, they can be considered as a virtual asset and a mean-variance framework can be used to allocate funds to them. These FX positions - strictly from a fund manager's point of view - are truly diversifying assets and thus can significantly enhance risk-return for the strategic asset trade.
Disclaimer
"Risk Latte uses proprietary and non-proprietary mathematical and empirical models to measure the volatility and estimate the direction of the market. There is no guarantee of any particular outcome happening and readers must exercise caution while interpreting the conclusions of this article. Risk Latte Company is not a registered stock broker or an SFC registered entity and readers must take advise from their financial advisors, stock brokers, research analysts and bankers while making any buying or selling decisions. Risk Latte Company is not in the business of making stock or asset forecasts whether explicitly or implicitly and shall not be responsible for and/or liable for any losses arising out of any trading decisions based on the above article."
Any comments and queries can be sent through our web-based form.
