Currency Traders in Worst Year Since 1991

By Paul Dobson - Oct 27, 2011 8:05 PM GMT+0700

Currency-trading strategies are losing the most in two decades as the volatility that’s boosted volume and profits for investment banks erodes the ability of investors to make money.

Three out of four Royal Bank of Scotland Group Plc indexes of foreign-exchange trading strategies are down this year, including a 2.7 percent drop through September for its carry trade index. Deutsche Bank AG’s dollar-denominated Currency Returns Index has fallen 3.4 percent, the biggest drop since a 4 percent slide in 1991. The Stark Currency Traders Index and the Barclay Currency Traders Index have declined by 8.6 percent and 0.4 percent.

Whipsawed by slowing global growth, central banks fighting currency gains, and swings between optimism and despair over the 17-nation euro area’s debt crisis, traders are reeling from losses in an environment that should have favored them.

“What’s really frustrating is that we’re supposed to do well in a lousy world market,” said John Taylor, the founder of New York-based FX Concepts LLC, the world’s largest currency hedge fund. Taylor said in an Oct. 19 interview in London that he has lost 12 percent this year and assets under management fell to $5 billion from as much as $8 billion. “We’re doing very badly.”

‘Walloped Every Time’

Losses started as early as the first week of January, when Chile’s central bank said it would buy $12 billion dollars to stem a rise in its peso, Taylor said. The peso tumbled 6 percent that week, erasing most of its 8.4 percent gain from last year.

“Our position was relatively large, it was 8 or 9 percent of our total assets, and there was no way to get out,” Taylor said. “What was bad about it was that a couple of days later Israel did the same thing, then a week or so after that South Africa did the same thing, then after a little bit more study Brazil did the same thing. We got walloped every time.”

The losses are a blow for specific types of currency funds that seek to lure investors with trading techniques that are designed to provide returns in economic declines as well as in periods of growth.

Other investment classes have also suffered. The MSCI All- Country World Index of equities slid 5.6 percent since December and S&P’s GSCI Total Return Index of commodities is little changed. The global bond market returned about 4.7 percent, including reinvested interest, according to Bank of America Merrill Lynch indexes.

Alpha Fund Gains

Global Capital Management NV’s GCM Alpha Fund, with 9 million euros ($12.6 million), has risen 13 percent this year, the most of 56 peers in a Bloomberg index of open-end currency funds domiciled in an offshore market.

The fund’s automated trading systems designed to follow market trends ended a bet on franc strength before the Swiss National Bank said it would prevent any appreciation beyond 1.20 per euro. The franc has weakened about 21 percent to 1.22227 per euro from its record 1.00749 on Aug. 9.

Global Capital also bought dollars before the Dollar Index rallied 6.3 percent in September amid concern Europe’s deepening debt crisis would trigger a global economic slowdown.

“We obviously didn’t know there was going to be the intervention and most people were still long Swiss francs then. That was very nice,” Jan Hillen, a managing partner at the firm, said in a phone interview from Brussels.

The fund scaled back its trading this month, he said.

Carry Trades Down

Carry trades, where investors borrow in countries with lower interest rates to invest in nations where yields are higher, often lose money in times of financial turmoil.

The RBS carry trade index lost 2.7 percent through September, after an 8.6 percent profit in 2010. Returns were hurt early in the year by bets on Chile, and in September as the U.S. Dollar Index rose the most since October 2008. That cut the value of positions funded in the greenback.

While central bank actions in Latin America had an impact, “the much bigger contributor has been the period of risk aversion we saw in the third quarter,” James Wood-Collins, the chief executive officer at Windsor, England-based currency manager Record Plc., said in a telephone interview on Oct. 20.

Funds managed by Record that focus on carry trades are down about 1 percent for the year, he said. “We continue to have confidence in the strategies,” Wood-Collins said.

‘Tough Year’

The style of trading that involves betting on established currency-market trends has lost 3.2 percent, RBS indexes show.

“It has been quite a tough year for trend-following systems,” said Maria Heiden, who oversees Hamburg-based Berenberg Bank’s 142 million-euro Currency Alpha fund, Germany’s biggest. “From May to August there has been no possibility to generate any returns” as the euro traded in a range, said Heiden, who said 30 percent of her fund’s “exposure” is to euro-dollar.

Between May 1 and Aug. 31, the euro traded between $1.3837 and $1.4940. That compares with a range of $1.1877 and $1.6038 since the start of 2008. It rose 1.2 percent to $1.4074 at 2:04 p.m. London time.

While September’s rally in the dollar boosted the fund’s returns, “what we’re seeing in October is a total trend reversal,” said Heiden, whose fund is down 4.3 percent year-to- date. The euro has strengthened about 4.8 percent against the dollar this year.

Worse still for currency traders are policy makers’ steps to stem the appreciation of the two best-performing Group-of-10 currencies, the franc and the yen.

Japan Intervention

The Bank of Japan has sold yen twice this year to weaken the currency, including a coordinated move by the Group of Seven to counter a jump in the currency after the March 11 earthquake and tsunami crippled the nation. Japanese Finance Minister Jun Azumi said yesterday that his ministry will take “decisive” measures to stem the yen’s rise after it surged to a post-World War II record of 75.72 against the dollar.

“I’ve ordered my staff to be prepared to take action at any time,” Azumi told reporters in Tokyo. “Speculative movements have become very prominent.”

Berenberg stopped trading dollar-yen “because the risk of intervention is too high right now,” Heiden said.

Results will improve as the euro-region debt crisis moves toward a resolution, Heiden said. “We know that after these political situations we will come back to a better environment, so we look forward to when markets trend properly again.”

Trading Revenue

Of the other strategies monitored by the RBS indexes, trading in currency volatility lost 8.3 percent this year, including a more than 17 percent plunge last month.

Implied volatility among currencies has increased 6.8 percent this year, according to a JPMorgan Chase & Co. measure. The JPMorgan Global FX Volatility Index was at 13.38 yesterday, up from this year’s low of 9.99 in March.

The RBS valuation strategy that bets currencies will return to so-called fair value levels over time is the only one of the four trading styles to have handed investors a profit, with a 2.2 percent return, including an 8.8 percent gain in September.

Losses haven’t kept revenue for brokers from rising. CLS Bank, the New York-based operator of the biggest currency- trading settlement system, said it handled a record $5.21 trillion a day in September. That was a 23 percent increase from the same month in 2010. Deutsche Bank, the world’s biggest currency trader, said Oct. 25 that it had record revenue from foreign-exchange trading in the third quarter.

“There was a huge amount of market uncertainty, the consequence of that was that clients had to do more and more business,” Zar Amrolia, the London-based global head of foreign-exchange at Deutsche Bank, said in a telephone interview. “Volatility will remain elevated for some time to come.”

Taylor discarded his holdings of Argentina’s peso on concern it’s poised to keep falling after a 6.1 drop this year. He said he adjusted his models to anticipate action such as Chile’s elsewhere.

“You have to have measures that explain as to whether the country is swamped with capital,” Taylor said. “Are we smarter about that? Yes, a little bit.”

To contact the reporter on this story: Paul Dobson in London at pdobson2@bloomberg.net

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net