Hedge Funds 2008 Till Now
Hedge fund performance over the past decade has not been that impressive in general, however, currency hedge funds have taken a particularly strong beating.
The FX market has proved disappointing to lots of investors in the years since the 2008 financial crisis, when the world’s biggest central banks launched stimulus programs to help breathe life into struggling economies. With monetary policies around the globe moving in one direction, currency markets turned quiet, robbing fund managers of the volatility they needed to deliver performance. Funds that specialized in currencies started to wind down, with a few large firms closing their doors as mediocre returns drove investors into more attractive assets, such as global equity markets.
The Bank for International Settlements (BIS) revealed a seismic slump in the total assets under management by quantitative Forex hedge funds. In 2008, prior to the worldwide recession, total assets amounted to $35 billion, with this number falling to just $6 billion in 2013.
In another jolt to the already under pressure industry, the Swiss National Bank’s removal of the Swiss franc’s peg against the Euro on 15 January 2015 severely impacted hedge fund returns, with assets under management falling even further. In addition, flash crash events began to periodically occur in currency markets, adding more fuel to an already burning fire.
Turning the Corner
Hedge funds have their origin in the speculation in international currency markets. Currencies have trends, crises, and turnarounds, all of which makes them ideal for speculation. But rarely does anyone invest directly in FX markets expecting long-term appreciation. Currency markets are speculative in nature, they’re not investment markets. The same statement holds true of commodity markets. Hedge funds are now very active in stock markets and are making stock markets much more like currency markets, that is, as vehicles for speculation rather than investment.
Global markets have been anything but boring in the second half of 2019. A trade war, global political tensions, Brexit, inverted yield curves and the early signs of global recession have brought volatility back into the Forex market. Geopolitical turmoil has put currency swings back into play, particularly where emerging market currencies are concerned. For currency-focused funds, the lack of price swings has been particularly hard. The Citi Parker Global Currency Manager Index, which tracks the performance of 14 Forex programs representing nine distinct investment styles, in 2018 declined to its lowest level since 2003. Despite a slow start of 2019, currency markets are no longer sleepy.
Much of the decline in FX investment in the previous decade was attributed to central bank intervention post-2008 crisis, while a compression of interest rates literally put a stop to the popular “carry trade” that was the essential strategy of many Forex hedge funds over the years.
Investors borrow a low-yielding currency and sell it to buy a higher-yielding currency. With the impact of quantitative easing now finally diminishing, I expect other macroeconomic drivers to influence global currency markets, bringing in the divergence and volatility that funds are craving.
Accessing Spot FX Markets - Past and Present
Since 2008, currency-only hedge funds have seemed to be on the brink of extinction with the largest one, FX Concepts, closing its doors in 2014. One might argue that it is a dying breed, but a renaissance might be well underway.
Recent events are proving that the sleeping lion might not be asleep for much longer and that investors around the world are hungry for currency market exposure again, particularly, those investors exposed to, or operating within, emerging market economies.
The task of getting back into the market, however, might not be the same in 2019 as it used to be in the past. The Swiss National Bank’s removal of its Euro peg in 2015 had a severe impact on FX prime brokerage industry, causing prime brokers to raise collateral requirements and fees and to cut clients. Many banks also cut their prime brokerage units’ exposure to retail (margin) brokerages.
Many funds are now facing increased hurdles in their attempts to locate reliable and reputable FX prime brokerage service as the amount of required capital has jumped significantly, along with tighter admission criteria and raised fees.
The answer is a “Prime of Prime” relationship, whereby funds are prime-brokered by a non-dealer entity, which is itself prime-brokered by an FX dealing bank. The Prime of Prime allows for faster access to currency markets and offers accelerated time-to-market as funds can tap into existing well-functioning infrastructures. Prime of Primes will generally offer higher leverage than a Tier 1 PB as well as “plug and play” integration into a single aggregated feed via an industry-standard FIX API or standard adaptors/connectors to various aggregators and ECN platforms. The Prime of Prime’s role is to extend interbank market access to clients who are looking to access FX markets in a fast and reliable way. To put it another way, it helps create direct market access for those clients who do not meet the stringent collateral and credit criteria that’s needed in order for them to establish their own, direct, prime broker relationship with a bank. The main value that a real Prime of Prime delivers is non-latent access to institutional trading, in a secure and regulated environment.
With the global economic climate experiencing uncertainty over the very many issues at hand, there is, once again, an increasing positivity in the Forex markets.
There is no doubt that a growing number of hedge funds will be looking to leverage currency trading to their advantage. There is also an increased need for the ability to hedge currency exposure amongst other players, such as private equity firms that are heavily exposed to volatile emerging markets economies.