07.03.2012
By Terry Flanagan

FX Broadens Appeal (Part 1)

(Part 1 of a 2-part series)

With equity performance choppy at best and interest rates languishing near historic lows, stock and bond investors have sought out alternative asset classes in which to park their money, and the foreign-exchange market has been a primary beneficiary.

“There has been a growing trend over several years of traditional equity and fixed-income investors getting more involved in FX trading,” said Sanjay Madgavkar, global head of foreign exchange prime brokerage at Citi. “This interest spans macro, systematic or high frequency trading strategies. The FX market is highly liquid, tends to have lower volatility than most equity markets and is typically subject to fewer disruptive events; as a result, it is attractive to investors and traders who have typically focused on equity markets.”

“By combining technology platforms and Prime Brokerage facilities, clients are able to access multiple pools of liquidity at a very low cost,” Madgavkar continued. “This has increased transparency and has made FX trading more accessible to FX traders across the spectrum, small to large.”

Foreign exchange is considered the world’s most liquid market, with about $4 trillion of currencies changing hands daily. For an institutional investor, the appeal is that that FX returns should be uncorrelated with those of the stock market.

“The goal is always to bring more diversification into your portfolio,” said Philip Simotas, president and director of investment management at FX Concepts, a $4.5 billion New York-based hedge fund that specializes in trading currencies.

“Like any asset class, foreign exchange has its own challenges in terms of devising an investment process that works consistently over time,” added Simotas. “We are like most investment managers, in that we are focused on trying to bring a broad array of styles into our investment process.”

One recent development in the FX space is its broader accessibility to smaller investors. Foreign exchange is not electronically traded to the extent equities are, but it is more electronic and less institutional than fixed income.

“Electronic trading has really taken over this market over the last several years,” said Simotas. “It has made it more accessible to investors, particularly the retail market, as a result of that. Banks have their own electronic trading platforms and there are also some ECNs and other FX trading platforms that have sprung up.”

Another recent change has been stepped-up FX volatility, induced by policy makers in the U.S. and Europe rather than market forces left to their own devices. Observers expect monetary stimuli and the ongoing European debt situation to continue to roil markets.

“In the global markets you have several 800-pound gorillas — the big central banks including the Fed, the ECB, the Bank of England, and others,” said Simotas. “We’re in a regime now with activist central banks that are using monetary policy very aggressive to try to stimulate economy, and that impacts price action in currencies. It has had a major impact over the past few years.”

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