These are halcyon days for currency traders. Over the past two years there have been many obvious mispricings between the major currencies, presenting plenty of opportunities for those willing to get in on the act.
Sterling plummeted against all major currencies following the Brexit referendum in June 2016, but anyone prepared to go long since then – particularly after the subsequent flash crash in October that year, which saw it fall to 1.21 against the dollar – has been laughing all the way to the bank.
Equally, it was tough to say that the greenback was anything other than overvalued, after hitting a 14-year peak against a basket of major currencies in December last year. Sure enough, the dollar has tumbled ever since and is in the midst of its longest losing streak in that 14-year period.
The euro also bottomed out against the dollar, after reaching near parity with the currency in the same month. It got as cheap as €1.04 to the dollar, but has climbed by 15% in the intervening months to €1.20.
The Liquid Alternatives Currency sector is not the most crowded, with just 23 managers named on 11 portfolios today, up from 19 three years ago. As you would expect, outcomes vary greatly between strategies.
There may only be one portfolio in the red over the past year, but performance in the rest of the category is not looking too healthy either, with the average manager up by just 5% – a long way short of the massive swings between the major currencies. Of course, there are many more components to the currency market than just the six most heavily traded, and in general the largest gains are to be made in emerging currencies.
This is where the top managers of the past year have focused their attention. Over the past 12 months Michael A. Cirami and John R. Baur, who run the Eaton Vance Diversified Currency fund, have returned 9.25%.
Rather than investing directly in currencies, their fund primarily buys near-currency instruments in the shape of short-duration sovereign bonds. These positions are then complemented by modest short derivative stakes.
The portfolio invests in 33 countries, with the bulk of its assets invested in Europe (48%) – primarily emerging Europe and the Nordics. The Serbian dinar is the best represented currency in the fund at 6.7%, followed by the Swedish krona (5%) and the Czech koruna (4.9%). After Europe, there are sizeable stakes in Latin America (21.7%) and Asia (20.1%), both of which will have added to the portfolio’s short-term returns.
In second place over the past year is Michael Gomez, who leads a team of four on the Pimco Emerging Markets Currency fund. The fund is up a similarly impressive 8.7%, having gone big on the Mexican peso (10.2%), the South Korean won (9.6%), the Chinese yuan (8.9%) and the Indian rupee (8.6%).
However, as promising as these returns have looked over the short-term, both Eaton Vance and Pimco have been less impressive over the longer term, and both carry high volatility. Over three years only one fund has generated double-digit returns, and that is the Leland Currency Strategy fund run by Neil R. Peplinski, Kenneth A. Froot and Paul G. O’Connell.
This strategy is a much purer liquid alts fund, with heavy use of foreign exchange contracts and a focus on the most heavily traded developed currencies. It is currently short the US dollar to the tune of more than 100% of its assets, with proceeds invested in the euro (20.8%), the Australian (17.1%) and Canadian dollars (18%), along with the Japanese yen (17.6%), the Norwegian krone (18.5%) and sterling (15.8%). The fund also benefits from its negative correlation to all major asset classes.