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Currency funds feel the pain


Foreign exchange specialists face challenging times. FX Concepts, once billed as the world's largest currency hedge fund, is winding down its investment management operations. It isn't the only one struggling, and the troubles aren't over yet.

Currency hedge funds have returned only 1.8 per cent between January and August, according to Eurekahedge data. That's half as much as those with a wider asset focus, and puts them on track for a second year of under-performance. Such forex funds typically latch on to clear trends, pick up on deviations from what is considered fair value, or enter carry trades which involve borrowing low-yielding currencies to invest in higher-yielding ones.

The difficulty is that there are few big trends on which to hitch a ride. Most major exchange rates are stuck in well-worn ranges. The yen's slide lasted little more than a quarter and sterling's rise lost momentum after a few months. Forex funds have sometimes jumped on a move only to find they bought close to the top of the market.

Monetary policy isn't divergent enough to generate big forex swings, given interest rates are low across the developed world. And the U.S. government shutdown and debt default risks may delay even the tapering of the Federal Reserve's quantitative easing program that was expected to buoy the dollar. The prevalence of low rates also reduces the scope for lucrative carry trades between currencies. Higher interest rates are offered in emerging markets, but recent turmoil there has made investors pickier.

Compounding the problem is the absence of an overarching theory of what is driving forex, now that markets have become less driven by varying degrees of fear. Correlations are breaking down as quickly as they are established. Moreover, forex volatility has fallen in the past two years. That hobbles more nimble funds that might have been able to profit from big gyrations, and makes life harder for options strategies.

Of course, forex funds aren't the only one feeling the pain. Some of the banks they deal with are also eking out currency trading profits amid fierce competition. A tough environment is likely to mean a greater concentration of market share - and fewer success stories in both camps.

© 2007 The Globe and Mail. All rights reserved.

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