Currency: Asset Class? Risk Class? Both.
January 27, 2012
Fidelity Investments did something last week that a decade ago most likely was not imaginable-or feasible.
The company best known for popularizing the no-load mutual fund said that, for the first time, it would allow retail investors to trade directly in foreign markets-and in foreign currencies.
In the past, this kind of direct access to foreign markets, securities and funds was reserved for active traders and wealthy individuals.
But times are changing, as is the view of what the currency of a nation actually constitutes. In traveling or in business, it is a medium of exchange. Thus, the term foreign exchange, when swapping printed notes or digits in one currency for the same in another.
But, in investing, currency is becoming a totem: A product of a country that is an emblem of its economic condition and its prospects.
"It's been predicted for a long time,'' said Jay Biancamano, executive chairman of Aritas Securities, the operator of a block trading venue and supplier of trading tools to large institutions. "Now, it's seen as having a tremendous amount of potential,'' as an asset class, just like stocks or bonds, that should be part of a well-diversified portfolio.
The classic example of how currency can qualify as an investing vehicle came in 1992 when George Soros, chairman of Soros Fund Management, nearly undid the British pound, by betting against the currency. He borrowed heavily in British sterling, converted that into German marks and French francs. And walked off with a profit of $1 billion.
That's a pretty penny.
But consider this: Daily trading volume in the global foreign exchange market was $4.0 trillion in April 2010, the last time the Bank of International Settlements conducted its Triennial Central Bank Survey.
That compared to $3.3 trillion a day, three years earlier.
The increase was driven by a 48% increase in spot transactions, which rose to $1.5 trillion of the total, from $1.0 trillion.
By comparison, only about $10 billion worth of stock changes hands each day on the U.S. equities markets, according to market statistician Trefis.
Which means lots of money can be made-or lost-quickly, with bets on currency movements.
And this is a period where the fates of nations, particularly in Europe, seem to swing almost day by day, in lockstep with the prospects of their being able to pay off their debt. That, in the minds apparently of even sophisticated investors, is beginning to turn currency into a way to express a belief in the prospects of the country itself.
"Clearly we're seeing a lot more interest in FX,'' said Jon Fatica, co-head of analytics at TradingScreen, which operates a global network that allows fund managers to access any market, any counterparty and any financial instrument, anywhere.
Although currency does constitute an asset class, he says, "It's still not recognized by the traditional asset managers as a way to express an investment view."
That is because there is no widely recognized way to measure performance. There is no Standard & Poor's 500, as is found to gauge long-term direction of stocks. Or an MSCI index, as is used to benchmark stocks in emerging or "frontier" markets.
In theory, though, the strength of a currency reflects essentially all factors affecting the economic condition of the country that issues it. This includes interest rates, unemployment, retail sales, housing starts, consumer prices, producer prices, commodity prices, overall national output and such.
This is why OANDA supplies information on national economics alongside the foreign exchange data and fully automated currency trading it supports on the Internet. Economic figures are graphed against historical economic data for major economic regions. The figures are compiled from data from central banks, national statistics offices, and other official sources. All to support instant trading and instant settlement of trades.
Which is how currency also reflects the times. Or the pace of the times. There is the huge liquidity ($4 trillion of trading daily), the unparalleled coverage (every country in the world has a currency), the low costs of transactions, the ability to use leverage to enhance profits and near round the clock operation of currency exchange markets.
In effect, if you want to invest in China, you can buy renminbi. If you want to bolt on Italy or Greece, you can empty Euros from your holdings.
"If you really want to bet on a macro environment, currency is probably the best way of doing it,'' says Steve Marchini, managing director at Aritas Securities. "Because it gets reflected instantaneously and you don't necessarily have to wait six months for that to pan out."
Marchini's point: If a fund manager is looking for short-term movement that reflects a particular conviction, "the currency market is probably the best vehicle to achieve that.''
Over the long run, however, it can be a "very difficult asset class to invest in," says Fatica.
"It's never quite clear what's going to drive the FX rate,'' Fatica contends, "whether it's balance of payments, interest rate differentials, psychology, fear, whatever."
Traditional asset managers that don't count currency as a viable class of asset for long-term investing can look at and analyze cash flows, market share or earnings per share, for instance, of the companies they invest in. Over four quarters. Over a year. Over five years. Over a quarter century.
With currency, Fatica notes, "the longer term trends are not clear and it doesn't move in longer term horizons as much as some of these other asset classes do."
As a result, currency "is still viewed as something of a secondary asset class," Fatica said.
But, currency is, he said, "clearly a risk class.''