Thursday, April 14, 2016

FX as an asset class? - what matters are factors

I visited the FXWeek North American conference across the street from my office. It is interesting that the issue of FX as an asset class is still being discussed as a topic. This issue just will not go away. While I think of it as an asset class, there are still many who are skeptical; nevertheless, we can change the focus from asset class to factors and then foreign exchange becomes more unique and useful. If the idea is that you would like to buy unique investment factors, currencies are good place to gain return and diversification.  In fact, some of the well-known factors that are applicable in equities or fixed income also apply to currencies but with a different return profile uncorrelated with other asset classes.

What are the factors that can be the focus of foreign exchange? The usual suspects apply to foreign exchange - carry, momentum, value, and volatility. Exploiting carry in FX is different than in the fixed income markets. It may be related to global risk but it has a different profile. It is a different way of playing carry. Momentum in currencies has been a long-term winner for investors which is different than the momentum in equities or commodities. FX value is much harder to measure than in other asset classes but it can be used as a factor. The same can be said about variance. All of these factors have been well-established in currencies, so if you want factor diversification you get it in currencies.

Providing uncorrelated returns on similar factors can be good way of determining the uniqueness of a an asset class. One can change the argument about asset classes and focus on different ways of expressing factor bets.

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