Currency for Return
Unlike our currency hedging products (which are risk mitigating strategies), currency-for-return investments are designed to actively allocate risk to currency risk permia, or factors, with a rational expectation of return. Our return-seeking offering focuses around a series of strategies designed to capture the main drivers of return in the currency markets.
Record’s Currency Multi-Strategy combines four separate sources of return in the currency markets: Carry, Emerging Markets, Momentum and Value. Each strategy is robustly engineered to extract value from the target factor, these are joined under a structure of discretionary risk management and dynamic allocation, governed by diversification constraints. By combining these four components in a single, balanced portfolio of approximately 30 developed and emerging market currencies, the Multi-Strategy product aims to deliver consistent returns in a variety of market conditions.
Carry is the empirical observation that higher interest rate currencies tend to outperform low interest rate currencies, despite inflation expectations. Carry can be thought of as a persistent risk premium based on the required export (import) of capital between countries with current account surpluses (deficits). By buying high yield currencies and selling low yield ones, Record’s Carry strategy offers a source of excess returns to investors willing to export capital to deficit countries.
Emerging market economies have traditionally grown at a faster pace than developed market economies. As GDP per capita in these countries converges towards developed market levels, relative productivity gains translate into real exchange rate appreciation through the Balassa-Samuelson effect. Furthermore, high real interest rates within emerging markets help finance this growth by attracting foreign capital. Investors can benefit from both growth and carry opportunities in emerging markets by taking structural long positions in economies with persistent relative productivity gains, funded by a short position in those economies with relative productivity losses (developed markets).
Currency markets are not entirely efficient; they display trending and mean-reversion behaviours at different time horizons. Momentum in currency is defined as the tendency of the spot rate to appreciate after prior appreciation, and similarly depreciate after a prior depreciation. Record’s Momentum strategy uses series of moving average crossover rules to capture the trending behaviour of currencies brought about by herding and hoarding behaviour, delta hedging flows and lagged information uptake.
Our research suggests that purchasing power parity (PPP) valuation models are a relatively good predictor of the long term direction of spot movements, although substantial deviations from PPP can be observed in the short to medium term. Record’s Value strategy seeks to profit from expected corrections of these deviations by buying currencies that are undervalued, and selling currencies that are overvalued, relative to PPP.