Long Live FXRreturns - Deutsche Bank
George Saravelos, Strategist at Deutsche Bank, notes that the
international press is replete with stories of poor investor returns and
discretionary fund closures this year.
“Reuters reports that Q1 2016 marked the first quarter of outflows from hedge funds since the financial crisis. Reports like this beg the question: is this the end of macro investing? Have FX returns structurally declined?
We attempt to answer this question by looking at the performance of the Deutsche Bank currency returns (dbCR) index, which aims to capture passive FX investing in a similar way the S&P 500 does so for equities. The dbCR has two benefits. First, it was launched in 2007, and has nearly 10-years of out-of-sample returns. Second, it follows the three most commonly used trading strategies for FX – carry, valuation, and momentum - and is therefore investable. We look at a 2-year rolling Sharpe ratio (returns/volatility).
The results are striking. The index has returned a Sharpe ratio of 0.6 over the last two years almost exactly in line with its medium term average. A quick glance at the index indicates no structural decline in FX excess returns, which continue to go through cycles of over- and under-performance. Over the last twelve months, carry trading has proven the worse while valuation trading (based on PPP) has proven the best.
So why are
discretionary returns poor? If returns still exist, it must be that they
are becoming more difficult to anticipate. After three years of major
central bank-induced trends (Fed lift-off preparations, Abenomics, ECB
QE), we would argue that markets are undergoing a major transition away
from central banks as a driver of markets. Declining visibility around
macro trends and central banks is becoming a rising constraint. Yet
there is a silver lining. History provides plenty of evidence where
themes other than central bank policy have driven market trends in the
past. Our best guess is that major changes to fiscal policy could be
such a driver going forward. It is not the time to give up currency
investing just yet.”