Currency markets, in many ways, represent an ideal asset class for investors. Not only are they a useful diversifier due to their potentially uncorrelated returns, but are also remarkably efficient due to their high levels of liquidity, and 24 hour nature. The benefits of this are that transaction costs are not prohibitive, and allow high frequency trading, especially in the major currency pairs. With few capacity constraints, the currency market is probably the largest, deepest, and highest volume market in the world.

A unique aspect of the currency markets is the number of market participants that intervene on a non-profit seeking basis. Professional investment risk-takers, dedicated to profiting from currency markets, only make up around 25% of market participants, as opposed to around 80% or 90% in other capital markets. The other market participants, such as Central Banks and corporates do not seek to generate profits as their primary motive for currency market intervention. Thus, the central tenet of the efficient market hypothesis is not applicable, and supernormal profits should accrue to the professional participants.

The global nature of these markets means that the return of currency managers should have a low correlation to other asset classes. This has been conclusively studied by several major banks. It has also been found that investing in currency managers may prove to be beneficial to a typical investment portfolio especially in times of stress when the returns on most other asset classes tend to get highly correlated to each other.

To illustrate this, we have aggregated the total monthly negative returns of the S&P 500 and Nikkei 225 equity indices since January 1997, and compared them to the performance of the Barclays Currency Index and Parker FX Index during those corresponding months.

This clearly highlights the potential diversification benefits of including currency managers in one’s investment portfolio.