Foreign exchange markets remained turbulent during July, with rate cuts in peripheral currencies' na...
Foreign exchange markets remained turbulent during July, with rate cuts in peripheral currencies' nations damaging some portfolios with unexpected trend reversals.
Fergus Walsh, manager of Appleton Capital Management's 25% Risk Currency Program, says: 'The overriding story for foreign exchange funds this year has been the strengthening of the euro against the dollar, although that trend has cut back a bit recently.'
Walsh adds the fund made 34.43% to the end of June, before giving back 10.97% in July. Appleton's fund trades in only four currencies ' the US and Canadian dollars, yen and euro ' and made money out of the euro/dollar cross. The fund only trades these currencies due to their trending characteristics, politically-stable background and liquidity.
He says historically the dollar has exhibited sufficient positive correlation with sterling, and the euro with the Swiss franc, to make trading these other currencies an additional cost without concomitant profitable trading opportunities.
The program forecasts directions currency pairs may follow over a certain time, using historical price data to forecast direction. Managers forecast volatility in the currencies over the same period using historic volatility.
Walsh says July proved difficult with the fund short the euro against the dollar, and long the Canadian dollar, a position that affected the fund given the surprise Canadian interest rate cut.
'The losses came in two tranches. The first was a result of the fall in the value of the Canadian dollar. The second, in the latter half of the month, was a result of the ranging behaviour of the euro,' says Walsh.
The US/Canadian rallied from 1.347 at the start of the month to 1.375 by mid-month before reaching 1.41, Walsh says, and although the model lightened the exposure, the trend still lost the fund 5%. The July set-back came after a June in which the program was long euro/yen and short the US dollar against the Canadian dollar, while being long the Canadian dollar versus the yen.
'As tends to be the case in profitable times the positions held by the model changed little through-out the month, as new price action confirmed the validity of what was already in the portfolio.
'If there was a slight shift it was from a dominant short Japanese yen position to a long Canadian dollar view. For the first half of the month the euro and the Canadian dollar continued to vie with one another for risk allocations,' explains Walsh.
In the second half of June, the euro came to the end of its profitable trend peaking at above 1.19 before falling to 1.1455 by month's close. The Appleton program then made a 'fairly rapid' reduction in the size of its euro/yen position, given a weakening in expected return from this cross. The long Canadian/ yen pair took up much of the slack from this move, which occupied 65% of the fund by month's end.
'The gains for the month were made in the first two weeks,' says Walsh, 'as the Canadian dollar/yen cross proved the most resilient.'
JWH Henry characterised July as a month of 'noise and reversals' in currency markets, and said economics remain favourable for the euro, but apart from this the main positive news for the US-based program was a reversal in trend for Poland's zloty. Investors in currency funds may have difficulty predicting trends when there is no sign of strong volatility in the markets, if research by Merrill Lynch is correct.
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