By JESSICA MEAD and KATIE MARTIN
Article from The Wall Street Journal
LONDON—Foreign exchange is finding new fans among hedge funds and global macro-focused asset managers, as tighter correlations between currencies and other assets prompt investors to use it as a proxy for other markets.
With a persistent state of crisis in the euro zone over the past year, key asset classes are now moving in lock step, leaving the correlation between the euro's exchange rate against the dollar and U.S. equity returns near historic highs. Oil prices and the euro are also unusually closely linked, while the Australian dollar's tie-in with global stocks is rock-solid.
To some investors, that is frustrating, because it hampers efforts to diversify returns.
But others are taking it as a cue to trade currencies as a proxy for less liquid assets elsewhere.
"With the outlook for the euro-zone crisis still very uncertain, investors use the euro as a short-term investment proxy to express their view on which way the saga appears to be heading. Accessing the foreign-exchange markets is often much easier and cheaper than trading directly in a country's bond or equity markets," said Des Morris, head of U.K. institutional client service at Wegelin Asset Management Funds SICAV—part of Wegelin, Switzerland's oldest bank. Wegelin Asset Management oversees 1.6 billion Swiss francs ($1.68 billion) in assets.
The Australian dollar is another key target. Australian commodity exports, particularly to China, leave its currency closely linked to global growth prospects, to Chinese growth and to commodities as a whole. That makes it attractive to investors keen for exposure to any or all of those elements.
"Trading the Australian dollar is a way of expressing many macro views, not just an Asia view," said James Pearson, head of spot currency trading at Royal Bank of Scotland Group PLC.
Liquidity in the currency is becoming sufficient to attract speculative traders, according to Mr. Pearson.
"It's a nice way to hedge other exposures," he said.
Other banks say that their clients are turning to currencies in growing numbers. "The S&P and the Australian dollar have a correlation of around 78%. So many clients are asking themselves: Why trade the S&P? FX is open 24 hours a day, you can trade at speeds of 13 milliseconds, you have very, very low transaction costs, and you can trade in large sizes," said Anil Prasad, global head of currencies and emerging-market rates at Citigroup Inc. in London.
"No major asset class experienced the type of volume growth we had in FX last year. For us, FX volumes grew by 30%, even more with some client segments, like institutional clients and wholesale banks."
On Monday, Citigroup launched a new, faster currency-dealing system, partly to help deal with these new clients. The system will handle only currencies at first, but is designed to handle additional asset classes over time, starting with commodities and rates, and later, stock indexes and credit.
Still, crossing over into foreign exchange isn't for everyone.
The constantly shifting nature of correlations—whether currencies will continue to move in line with other assets—will make some funds skeptical of incorporating it into their trading strategies on a regular basis. Some funds aren't permitted to move into new asset classes under the terms of their investment mandates.
"It would depend very much on the fund. Some funds are limited by the percentage of their portfolios or a measure of value at risk," said Adrian Owens, an investment director managing fixed-income and currency-based hedge funds at investment firm GAM. The company has $60.2 billion in assets under management and is part of GAM Holding AG.
Moreover, dabbling in currencies doesn't always generate returns. Even currency-focused hedge funds lost 3% on the year in October, according to the latest available data from Parker Global Strategies, which invests in currency hedge funds. Last year is widely regarded as having been a dismal time for currency traders.
Still, enthusiasts include global fixed-income and global macro asset managers, who tend to be keener than their counterparts in equities, according to Nick Spencer, director of consulting at investment firm Russell Investments.
Write to Katie Martin at katie.martin@dowjones.com
Article from The Wall Street Journal