Improving the odds in a dangerous game

Although most are hiding on the sidelines, hedge funds have been lining up to attack the euro single currency, following perceived weakness of economic conditions in Greece, Spain and Portugal. At the beginning of February, figures from the Chicago Mercantile Exchange showed more than 40,000 net short positions, representing bets of $8bn (€5.8bn), against the euro. Unlike the days of George Soros and his Qauntum fund in 1992, when the legendary Hungarian-born financier forced sterling out of the European Exchange Rate Mechanism, through a $10bn short position on Black Wednesday, today’s bets are systematic, computer-led trades. These are often conducted through a High Frequency Trading system, where the computers are positioned remotely from the fund houses, but as physically close as possible to the exchange to boost the speed of the transaction. “Remote hosting can give you a 100 millisecond advantage in the timing of your trade,” says Karsten Schroeder, co-founder of CTA managers Amplitude Capital, where he specialises in systematic trading of futures and options. “You need glass fibre cables to transmit the messages and everything is a question of your infrastructure.” Although Mr Schroeder acknowledges these advancements, he believes currency speculation can be a dangerous game, as the ten big hedge funds who have traded between the euro and the US dollar have two of the world’s strongest central banks lined up against them. Despite the subsuming of most European currencies into the euro, William de Vijlder, global chief investment officer for long-only and alternative strategies at BNP Paribas Investment Partners, believes there are more opportunities for hedge funds involved in currency trading than in 1992. “Back then, investors were only really trading the French franc, sterling and the Italian lira. Today there is a much broader menu.” He remembers how hedge funds had a clear conviction in 1992 about the pound’s weakness. Today, he feels, there is not as much direction in currency markets, although the dollar against the euro is an attractive bet. At Lyxor, the Société Générale hedge funds arm, senior asset allocation strategist Stefan Keller warns that the currency game today is not the most lucrative one which clients can play, with high correlations among assets expected in 2010. Global macro and fixed income arbitrageurs are his favoured allocations. “The current transition phase is detrimental to trend followers,” suggests Mr Keller, meaning CTA managers, many of whom specialise in tracking currencies, may not be so well suited to the conditions. But Lyxor does expect the US dollar to rise against the euro. Mr Keller also expects fresh weakness in sterling and a marked appreciation of China’s renminbi over the next two quarters. Although “normal volumes” of hedge fund trades are being pumped through currency markets, Ian Headon, head of product development in Northern Trust’s global alternatives business, sees a spike in demand among fund clients looking to improve currency hedging, due to market volatility. “It’s impossible to get the perfect hedge, but it’s our intention to get enough data to the fund manager as early as possible, to help them structure the hedging transaction,” says Mr Headon, who deals with hedge fund clients in European and Caribbean jurisdictions. “A currency hedge which is executed badly can have a significant drag on performance.” Damian Handzy, chairman of New York-based hedge fund consultancy Investor Analytics, suggests private banks should diversify risks by choosing a handful of “nimble” forex experts, but over-diversification, can lead to a “complicated portfolio that is difficult to manage”, he warns. “There may be several ‘Soroses’ emerging from today’s currency markets because there are so many more players in FX than in 1992. But picking them before their success is very difficult, which is why diversification isn’t just about mitigating risk: it’s also about having money spread around a number of managers, any of whom may be the next George Soros,” believes Mr Handzy.