Life in a low-return world: Every basis point counts
Last time I explained the benefits and variable scenarios of currency hedging – both static and dynamic. As we saw, the opportunities available in currencies can often be overlooked within an investor’s core multi-asset strategy. We think there are four strategies that can be employed to manage risks and make the most of the return opportunities from currency:
- Reduce unrewarded risk with static currency hedging
- Manage currency risk smartly with dynamic currency hedging
- Seek additional returns with currency factor strategies
- Employ cost-efficient implementation
Today in the second part of this blog series, I’ll be looking at strategies three and four on the list: currency factors and cost-efficient implementation.
Seek additional returns with currency factor strategies
Currencies can be exploited as an intentional return source in a multi-asset portfolio, just in the way traditional asset classes can be. At Russell Investments, we believe that there are three main drivers of currency returns to consider (which we call ‘factors’): Carry, Value and Trend.
Return-seeking currency strategies
These three factors can be used in the dynamic hedging of currency risks in investor portfolios (as we saw in part one). They can be used to dictate return-seeking currency strategies that are not tied to the investor’s underlying asset allocation.
It is important to note that, when in isolation, each of the three currency factor strategies can experience periods of significant negative returns. These drawdowns however, usually do not occur at the same time and therefore continue to offer alternative sources of diversification and return.
A flexible return-seeking currency strategy that considers all three currency factors at the same time is key. They offer strong risk adjusted returns with low correlation to traditional asset classes. This combined with an awareness of the changing market conditions, can in our view, achieve smaller drawdowns and a better balance of return to risk.
Employ cost efficient implementation
Investors have long suffered and battled with high costs in foreign exchange (FX) transactions. As such, currency hedging and return-seeking currency strategies hugely benefit from cost-efficient implementation, whether that’s through an electronic trading platform, or via an experienced implementation partner.
Electronic FX platforms
Modern electronic foreign currency trading platforms, specifically designed for asset owners and managers, work to broadly lower the cost of FX trading by:
- providing users with a central limit order book
- superior netting
- buy-side to buy-side matching
Like platforms, implementation partners also aim to reduce performance leakage by minimising costs.
Dedicated to reducing unnecessary costs and unrewarded risk, implementation partners access liquidity across all asset classes to reduce transaction costs and manage risk in investment portfolios. Their processes are designed to be client centric, flexible and to employ the latest advances in technology (including the use of electronic FX platforms).
Remember, every basis point counts!
As we can see, when in a low-return world, ignoring currency is not an option. There are numerous ways that multi-asset investors can make the most of their currency exposures and minimise trading costs to increase overall net returns.
Coming soon – Currency experts Van Luu and Joe Hoffman will be put in the investment hot seat as we ask:
- What’s the outlook for 'safe-haven' currencies?
- Should investors be hedging currency risk in their portfolios?
- To what extent are factors responsible for currency returns?
- What practical steps can you take to improve currency management?