The foreign currency market allow experienced traders to express macro views and extract alpha from a source which is highly liquid and non-correlated to traditional asset classes.
Around $4 trillion is traded on the FX market each day. This is more than 9x the daily turnover of global equities and 5x the U.S. bond market.
Liquidity does not, however, equal efficiency. With market participants pursing different agendas (which are not necessarily profit-motivated), there are opportunities for investment managers to generate alpha.
Currency returns have traditionally exhibited low, and in some cases negative, correlations to traditional asset classes (correlations calculated on monthly data).
Foreign currency exposure exists in virtually all institutional portfolios.
Passive FX Overlay, in which the only permitted trades are those which reduce exposure, has been used for over 30 years to hedge the underlying foreign currency exposures in Overseas Equity and Bond Portfolios.
Active FX Overlay, in which trades reducing and increasing exposure are permitted, was developed due to dissatisfaction with the results of Passive Overlay. Trades are limited to the currencies in which the natural exposure exists.
The acceptance of FX as an asset class and the emergence of theFX Alphaindustry, culminating in the CitiFX Access investible indices, has rendered traditional Active Overlay obsolete.
The state of the art solution to Overlay is to hedge all foreign currency exposures back to the base currency and to introduce an unfunded return stream from an investible FX index with a strong risk/return profile at a pre-agreed target volatility.
Investments in FX as an asset class have also been accepted as a vital diversifier in the alternates section of a well balanced portfolio. Traditionally, there have been four main issues for institutional investors:
How to make significant allocations to the FX space safely?
How to invest in a balanced selection of the best FX strategies without the excessive fees of traditional FX multi-strategy products?
How to track performance in a simple and transparent way?
The ARSAlpha Blend®indices were created to solve these problems.