Pension fund uptake of managed currency funds has been relatively slow, but bank-owned platforms are making access easier for investors looking to allocate foreign exchange exposure to their portfolios.

Persuading large institutional investors such as pension funds to make pure foreign exchange (FX) allocations has been a slow process, but the major FX banks are increasingly offering platforms that provide investors with access to several currency managers. This is helping to grow the volume of assets under management.

A year ago, Citi set up CitiFX Access, and at about the same time Morgan Stanley entered the market with FX Gateway. These two new entrants have been challenging the long-established dbSelect platform offered by Deutsche Bank. More new FX entrants may be on the way, while broader managed accounts platforms, such as Lyxor at Société Générale, offer their clients some FX strategies.

One of the main challenges facing these platforms is the fact that many currency hedge funds turned in a poor performance in 2011. The Parker FX Index, from US-based Parker Global Strategies, recorded a negative return of 2.62% for 2011, and for the current year to July it was down 0.59%.

These broad headline performance figures negatively impact investor perceptions, and a poor 2011 had a lagged effect on new allocations. However, many investors such as pension funds remain interested in putting on FX exposures, which are expected to have low correlation to their equity and fixed-income portfolios. A good run of returns to December 2012 from the better performing FX managers will likely help stimulate more investor interest.

Platform potential

From the investor point of view, going via a platform has a number of advantages. The investor faces a major bank as counterparty risk instead of a currency manager, and the platform clears all FX trades, providing a valuable oversight function to check that strategies are as advertised. This addresses heightened investor concerns about fraudulent activity in the wake of the scandal involving Madoff Investment Securities.

For the individual currency hedge funds, being added to a bank platform brings the potential for wider distribution and new allocations in addition to those made directly into their flagship funds. Many managers seek to be represented on several platforms.

"Our investors are looking for the alpha generated by the currency managers, with minimum use of capital, and we offer a broad range of ways to access this exposure, tailored to individual investor requirements," says Effie Datson, product head of dbSelect in London. The platform was set up back in 2004, and has built up an assets under management (AUM) figure of $5bn, although this includes commodity trading advisors as well as pure FX strategies.

"About 40% would typically be securitised products, such as certificates or notes issued by Deutsche Bank, 40% over-the-counter [OTC] derivatives such as total return swaps, and the remainder [would be] products such as undertakings for collective investments in transferable securities funds, sharia-compliant wraps and so on," says Ms Datson.

"Many European pension funds already have a dealing relationship with Deutsche Bank, and will trade OTC derivatives under that existing relationship. In Japan, yen-denominated principal protected notes are popular," she adds.

Our investors are looking for the alpha generated by the currency managers, with minimum use of capital, and we offer a broad range of ways to access this exposure, tailored to individual investor requirements

Effie Datson

There are currently 165 managers on the dbSelect platform, of which 72 are pure FX programmes. More managers are being continuously added, as long as they have successfully passed the platform's due diligence requirements.

"We are always looking to add good new managers, including some who are smaller and less well known, and we have a good breadth of currencies that our managers are trading," says Hans Feder, global head of dbSelect in London. "Many institutional investors would find it hard to invest with these managers without the sort of infrastructure that dbSelect provides. We provide transparency, and Deutsche Bank guarantees daily liquidity, with no lock-ups or exit fees."

New entrants

The CitiFX Access platform was set up in September 2011, and within 12 months had accumulated AUM of $1.5bn, with more sizeable allocations expected by the end of the year. The platform is also looking to add Commodity Trading Advisor access for investors.

The strategy is to offer access to indices, so exclusive deals have been signed with several benchmark and alpha index providers, though the underlying managers included in the indices will likely be on rival platforms as well. The platform offers indices or fund-of-fund solutions, which then allocate to individual managers.

In terms of indices used, the BarclayHedge BTOP FX Index is a widely followed benchmark, tracking returns of some of the largest currency managers measured by AUM; the Parker Benchmark tracks the best performing managers in various style buckets; investment advisor Absolute Return Strategies adopts a fund-of-funds-style, selecting those managers that it expects to generate the best returns; while Quaesta Capital uses a thematic methodology to select managers that deliver one of three performance styles.

"In addition to access to indices, we are also seeing interest from investors in running their own selection process from the 40 managers on the platform, to create customised strategies," says Stephane Knauf, global head of CitiFX Services & Products. "We are delivering the returns mostly via total return swaps, which are sometimes wrapped by the investor, for example into funds, trusts or notes. We have seen sizable alternative asset allocations from large institutions, such as pension funds and asset managers in the US and Europe. We have also seen strong interest from private banks and asset managers in Asia, looking to distribute to high-net-worth individuals and retail accounts who would usually find it very difficult to access exposure to sophisticated FX trading strategies."

The FX Gateway platform was launched by Morgan Stanley in October 2011, offering a select and pre-filtered group of pure FX strategies to investors who could already use the Morgan Stanley multi-asset managed accounts platform to access a variety of other strategies. One year later, FX Gateway has 12 managers on the platform. Managers are independently selected by Mercer Investment Consulting, in accordance with criteria that Mercer also assisted in establishing specifically for this platform.

"Our strategy is not to be a currency manager supermarket, but to have a select group of managers on the platform," says James Rogers, head of FX Gateway at Morgan Stanley in London. "Investors can get exposure to an equally weighted basket of all 12 managers, which would generate returns similar to a benchmark index. However, most of our clients are interested in selecting their own customised group of currency managers."

The new FX Gateway platform from Morgan Stanley, which we joined this year, is putting a lot of resources behind the marketing and distribution of the managers of the platform, and the pipeline looks good

Paul Chappell

Mr Rogers says that the bank has robust operational processes that examine how trades are allocated on a daily basis, and ensure that the strategy is being followed in line with the defined reference strategy. "Our aim is to minimise any tracking error, making investors confident that these accounts represent the strategies that were originally outlined by the currency manager. Investors also value the fact that there is full transparency, with the different currency manager strategies and competitive fees set out with standardised volatility," he says.

Comfort for investors 

Clearly the currency managers hope that 2013 will bring sizable new allocations, as more pension funds and other players are persuaded of the merits of FX exposure. One analyst points out that some of the biggest global macro funds have become so large that their presence is impacting the market. By contrast, currency managers are relatively small – an AUM figure of $4bn would be regarded as large.

"The new FX Gateway platform from Morgan Stanley, which we joined this year, is putting a lot of resources behind the marketing and distribution of the managers of the platform, and the pipeline looks good, though for large institutional investors the process of deciding on and approving new allocations can be quite slow, given the more stringent regulatory environment," says Paul Chappell, chief investment officer at C-View, a UK-based currency manager that follows a diversified trading strategy involving 32 different currencies.

"Traditionally a handful of very large currency managers have received most of the allocations from institutional investors, but platforms such as dbSelect, FX Gateway and CitiFX are giving investors easier access to a wider range of managers," says Mr Chappell.

Pablo Frei, head of multi-manager programmes at Quaesta Capital in Pfaffikon, Switzerland, says his firm’s strategy is specifically to be present on all the leading global platforms in order to attract new allocations. The currency manager joined Morgan Stanley’s FX Gateway this year, offering investors its v-Pro long short volatility programme, which has posted a return of 10.81% in the year to end August, with annualised volatility of 8%. He says that the build up of pure FX strategy AUM over the past five years has been slower than the firm might have expected.

“The v-Pro programme has generated good returns on a risk-adjusted basis, and it is important for investors to understand the necessity of analysing return versus risk, for example using sharp ratios and tail-risk exposure. A growing number of institutional investors such as pension funds are looking at putting on FX exposures via platforms such as CitiFX Access, FX Gateway and dbSelect, though many still choose global macro exposure with some FX, rather than pure FX strategies," says Mr Frei.

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