Quants: carry and value will work for next six months

Less volatile market conditions look favourable for these strategies

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Seeking alpha: portfolio managers look for returns with carry trades

Currency markets are ripe for further value and carry trading, because the factors supporting these strategies are likely to remain intact over the next few months, according to a panel of portfolio managers at the 10th annual FX Invest North America conference in Boston on April 12.

"Over the next six months or so, there is globally the foundations for things like carry to continue working are there," said Sean Geary, FX portfolio manager at Acadian Asset Management. "I think a lot of things that would drive a drawdown in carry are set to happen a little further down the road – they have been put off a little bit."

Upticks in volatility tend to destroy returns on carry trades, and the commodity-driven moves that saw emerging markets currencies whipsaw last year due to fears over China have not favoured this strategy.

The method worked well during the past quarter, however, because the US started to normalise its policy while the European Central Bank moved further along with quantitative easing. Geary believes this helped to change risk sentiment and investors' views on the driving factors in the market.

There will probably be continuation of decent economic data in the near term, which will again favour strategies like carry, where you can earn that interest rate differential without a sharp drawdown
Sean Geary, Acadian Asset Management

"I would say our fears of a Chinese devaluation receded, the fears of a US recession receded, and that sort of set the stage for investors to look at what the real yields were, to look at where carry can be earned [and] where current account imbalances are," he said.

"There will probably be a continuation of decent economic data in the near term, which will again favour strategies like carry, where you can earn that interest rate differential without a sharp drawdown. Other than that it is a little tougher," Geary added.

Top-performing currency managers saw returns of 7% in November 2015, according to the Parker FX Index, which, as a whole, saw an average return of 0.87% month-on-month due to the rising US dollar – a result of the expectation of a Federal Reserve rate hike in December.

Part of the more robust, less volatile sentiment regards China, which could also spell the end of carry-favourable market conditions. In November, the International Monetary Fund decided to include the Chinese renminbi in its special drawing rights (SDR) basket, which sets it on the path to gaining reserve currency status.

The IMF will expand its basket to include the renminbi on October 1, potentially causing an uptick in market volatility, as reserve portfolio adjustments get under way to reflect the new balance of currencies. Once this happens, countries will need to determine whether they want to hold that exposure or hedge to reach their desired currency composition.

October eyes on China

"Once we have meetings in October on the special drawing rights, I think that is when China will drive volatility in the market," Geary added.

Volatility in the G10 space could also pick up due to Britain's vote on its membership of the European Union. The approaching referendum on June 23 has been driving volatility higher in sterling and opinion polls showing a close call in the run-up to the vote could lead to shake-ups in the market.

"It's impossible to tell where sterling is going at the moment," said Michael DuCharme, head of currency strategy at Russell Investments.

Ritirupa Samanta, managing director and head of quantitative research, and senior portfolio manager at State Street Global Advisors, believes a combination of strategies could take hold as fundamental corrections drive valuations and carry differentials over the next six to eight months.

Invest in many, not one

"You kind of have to look at countries or pairs where you are actually getting compensated for the carry and go into those markets, and not into others," she said. "It would be the relationship between carry and value that is very well established... I wouldn't put my money in a single carry ETF (exchange-traded fund). I would put it into something that is a balance of carry and value."

Yield-hungry investors have become more interested in foreign exchange trading, because global FX currency markets have the potential to generate uncorrelated returns to other asset classes. But, even with this potential, some portfolio managers are not as enthusiastic about the outlook for carry strategies.

"I am more pessimistic, because when you look at the risk-adjusted carry, especially in G10, it is at a historical low," says Aysu Secmen, portfolio manager at Koch Supply & Trading.

"Both within G10 and emerging markets, the currencies you are taking long positions in are not necessarily the healthiest economies. Most of these countries have current account problems – deficit countries. Not all of these long positions are in undervalued currencies, so I am generally a little pessimistic on carry for this year," she added.

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