by | Aug 31, 2016 | Hedge Funds

Last Updated: August 31, 2016

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Currency Hedge Fund

It is no secret that hedge funds have been struggling for several years now. The widely followed Bloomberg Global Aggregate Hedge Fund Index so far is up 1.2% for 2016. This represents the third consecutive year that it has seen lower than two percent returns. Yet there is an encouraging sector in the $2.9 trillion hedge fund world. This is currency strategy hedge funds. Their strategies are all equalling or surpassing 3% returns. One fund in particular has averaged five percent per year since its founders established it.

Currency Strategies Outperform Hedge Fund World

There are three main currency strategies that the hedge funds follow. Each of them is beating the Bloomberg Hedge Fund Index’s 1.2% for the year. The carry trade is the strategy where the fund borrows from the main G10 currencies of the world that have lower interest rates. They then take this money and purchase higher yielding assets in other currencies. The Deutsche Bank AG index shows that this trade is having its best yearly gain since the year 2012. It has yielded 5.8% so far this year, a dramatic turnaround from the 7.7% drop seen last year.

Another hedge fund strategy purchases currencies which are undervalued at the same time it sells more expensive ones. This is known as the valuation strategy. It has returned 5.1% for 2016 so far. It is now on pace for a fourth consecutive year of solid gains, per Deutsche Bank’s data.

The momentum strategy jumps into trades that are based on trends in foreign exchange. This includes trends such as a weakening Swiss franc or British pound. This has been the weakest of the currency hedge fund strategies this year. It is still up 3% so far for 2016.

PGI Fund Outperforming Other Currency Strategies

One unique currency strategy fund is outperforming the others in its segment consistently. It is a part of the Principal Global Investors’ Macro Currency Group, also known as PGI. PGI’s Global Time Diversified Strategy manages $830 million. It has provided returns of 13.8% for 2016. This makes it the third best performer of 30 hedge funds that Citigroup tracks. The return is also almost five times greater than the Hedge Fund Research Macro Currency Index’s 2.9% gain for 2016 through July.

PGI vs Hedge Fund Returns

The Secret Lies in Once A Year Computer Calls

PGI is utilizing computer driven models to create strategies for its trading. This is common with many hedge funds. What makes their strategy unique is that their computers create such calls only one time each year. The way it works is refreshingly simple. In January, the computers come up with longer time frame economic projections. They then set out the next 12 months main trading strategies. Sometimes the calls do not seem obvious or even logical.

For the year 2016, the company’s computer models had the Japanese yen rising against the Swiss franc. Currency forecasters expected the pair to remain about even for the year. The trade worked out quicker than a year. In the first eight months of 2016, the yen has risen 14% versus the Swiss franc. The reasons for this were skepticism that the policies the Bank of Japan had pursued would boost inflation and safe haven demand. PGI’s computer models saw it coming as they track particular economic gauges. These include leading economic indicators such as manufacturing data. Such growth and valuation indicators cause the moves in currencies over the longer term. The PGI computer program modelers claim that the drivers of currencies are based on a one year time period.

Humans Also Make Successful Calls

You do not have to consider an investment in PGI’s Global Time Diversified Strategy fund only based on the prescience of their computer programs and models. They have help from the human team of managers. Mark Farrington the fund money manager leads the group in risk adjusting the portfolio as necessary and trading around short term events that create temporary fluctuations. Anything that occurs within the year, such as for a week or a month, the fund treats as a discretionary trade.

The people at the fund were the ones who came up with the computer models in the first place. They back tested more than 20 years of economic information to come up with their growth indicators. The fund then paper traded the strategy annually beginning in 2007 through the end of 2010. They were able to launch it with live trading for 2011. This hedge fund has boasted an average of over 5% returns each year since the 2011 launch. The gains are not primarily limited to the computer strategy either. Instead they are almost evenly divided between the human trading efforts and the once a year computer trading, per PGI. If you are not completely sold on the computer driven strategy, London headquartered PGI also offers another option that is solely human discretionary trading.

Sticking With Their Strategy Helps to See The Fund Through Volatility

Consistently sticking with the computer strategies has helped the PGI fund to ride through Black Swan events. One of the calls for 2015 involved shorting the Swiss franc in the belief it would fall for the year. Two weeks later the Swiss National Bank abandoned its currency ceiling versus the Euro. This caused wild currency swings that ended up with the franc rising more than 20% measured against the dollar in only that single day. Many hedge funds would have cut the losses to stop the bleeding and taken the serious hit. PGI saw it through and held the short position for the rest of 2015. By the end of December, the losses had been recovered with the Swiss franc giving up most of the gains. They held the position into 2016 and made money on the computer strategy in the end.

Wesley Crowder

W.D. Crowder is an American published author. His background and areas of expertise include history, economics, retirement, finance, expatriate living, international relations, investments, and personal finance. A widely read and top of his class graduate of Stetson University, he obtained his bachelor of arts degree in History with minors in Latin American Studies and International Relations and a special emphasis in Economics. He was President of his Phi Alpha Theta (National History Honors Fraternity) Stetson University chapter and a Phi Beta Kappa (National Honors Fraternity) member.