Traditional asset managers are growing more comfortable with foreign-exchange trading, and while many are dealing directly over the phone with large banks to facilitate their FX trading, some are crafting their own FX trades on electronic platforms.
“There is more of a rush in the FX market for asset managers to gain control of the process of investing, and get a better handle on costs,” said Matthew Sherman, senior trader at the Ohio Public Employees Retirement System. OPERS held assets of $80.3 billion, as of Dec. 31, 2012, and is the largest public pension fund in Ohio.
The asset management community has several reasons for tapping into the FX market, though the main one given by several firms that talked to Traders Magazine was to fund the purchasing of foreign securities. (Most do this by executing a spot trade, swapping U.S. dollars for the foreign currency needed to purchase the securities.) Another reason is to hedge a long equity position in a foreign stock by using a forward contract to secure a favorable future conversion rate in the foreign currency.
Increasingly, however, some fund managers are even becoming emboldened enough to make separate FX trades-unrelated to foreign equity trades-for dedicated currency or emerging market funds.
Similar to the overall FX market, spots and forward contracts are two of the most popular FX tools asset managers are using in their trades. Chiefly, asset managers are using spot trades-a trade of one currency for another at a set rate-as financing or to take advantage of favorable currency rates, and using forward contracts to hedge, especially in connection with a foreign equity purchase.
OPERS’s Sherman said he trades FX primarily as funding for the pension group’s international securities sales or purchases, and this comes from across all client accounts. However, he also makes stand-alone FX trades for the group’s midsize emerging markets funds. His desk mainly does FX spot trades, swapping U.S. dollars for emerging currencies, and when it hedges on an equity trade, it uses forward contracts, Sherman said.
OPERS uses FX Connect for its FX trading activity, Sherman said. FX Connect is the FX multibank platform for institutional investors, created by a unit of State Street Global Markets, the brokerage division of State Street.
“We want to do whatever we can do to manage things ourselves instead of having a custodian or broker/dealer do it,” Sherman said of OPERS’s online FX dealings. Indeed, for the first time, OPERS used algorithmic trading in the FX market this year. “Algos allowed us to look for other liquidity, not tip our position and manage our risk,” he explained.
The biggest asset managers, of course, have been in the FX market for a while, and many have sophisticated FX trading strategies, numerous dedicated currency funds and aggressive FX trading desks. But now, in the midsize and smaller buyside community, FX is starting to catch fire too, and those firms are leading the pack when it comes to trading FX electronically.
Indeed, fund managers and pension managers used multidealer platforms on 56 percent of their volume in 2012, higher than any other component of the FX market, including corporates and hedge funds, according to a survey conducted by Greenwich Associates and included in a report released in April. (In 2012, Greenwich Associates changed the methodology it uses to quantify electronic trading activity, making past comparison difficult; however, the report stated, looking forward, 62 percent of fund managers and pension managers said they planned to use multidealer platforms in 2013.)
Still, asset managers have a way to go before compiling the FX trading volume that banks and corporates dominate. Fund managers were responsible for 17 percent of FX global volume in 2012, and that was a tick lower than the 18 percent they notched in 2011, according to the Greenwich report. By comparison, banks, retail aggregators and hedge funds had 26, 20 and 12 percent, respectively, of global FX volume in 2012.
Eaton Vance is another buyside firm seeing the benefits of an aggressive approach to the FX market, benefits that include a new currency fund that has grown tenfold in the past year, allowing the firm to use the fund’s inflows to ramp up activity in the FX market.
“We’ve been absolutely busier in FX,” said Michael O’Brien, VP and head of global trading at Eaton Vance, adding that activity in this area has certainly picked up over the past six months to a year. “I think U.S. investors are now just getting used to the idea of FX as a separate asset class that can be tapped for yield.” Eaton Vance and its affiliates managed $260.3 billion in assets as of April 30.
That rapidly growing currency fund, Eaton Vance’s Diversified Currency Income Fund (EAIIX), is a retail mutual fund that has seen significant inflows from investment advisors looking to give clients some FX exposure, said O’Brien. The fund has ballooned in the past year, with assets growing to $565.6 million as of March 31, compared to $47.2 million in March 2012.
“There are a number of currency funds out there, but ours is the most diversified,” said O’Brien, adding that the fund trades in and out of between 40 and 60 different currencies. The fund pursues less-covered currencies, places like Sri Lanka, Vietnam or the Republic of Georgia, O’Brien said. “We want to be out on the frontier, and stay away from the more crowded trades.”
O’Brien says he allows his FX traders to use any variety of execution methods, from telephone calls to FX brokers to electronic multibank platforms, like FX Connect or FXall, the multidealer platform run by Thomson Reuters. One method gaining some favor among FX traders is the use of FX agency brokers, entities that gather streaming pricing data from a number of liquidity sources, mostly banks. The agency broker acts similarly to multibank platforms, in that FX traders can evaluate a number of different liquidity sources and pricing options, but agency brokers also offer anonymity-the trade appears to be coming from the agency broker itself instead of the asset manager. And this can be helpful if a firm doesn’t want to tip its hand about its positions or strategy, O’Brien noted.
Of course, not all asset managers engage in active trading for their clients in the FX sphere. Several interviewed by Traders Magazine said they use FX in a limited fashion and then primarily as a funding play or to hedge bets in foreign equities. Gordon Gary, head of trading at Philadelphia International Advisors, an investment management firm that specializes in foreign securities and had $2.9 billion under management as of March 31, said his firm mainly will trade in the FX markets to get the currencies needed to purchase foreign securities. While PIA does use FXall for some of its FX trading, it does much of it directly through the larger banks because of mandated custodial arrangements the banks have with certain PIA investors.
Because fund families like Eaton Vance and others are embracing FX, some of the FX venues known for attracting asset manager clients are already seeing some volume gains. For example, GTX, the institutional trading business of GAIN Capital, saw phenomenal growth, notching year-over-year volume growth of 119 percent through April 30.
Hotspot FX, owned by Knight Capital, is in the early stages of building out a service to attract asset manager clients. This service will allow them to trade FX trades at a future date and also provide pre- and/or post-trade allocation services for their FX trades. John Miesner, global head of sales at Hotspot FX, said he expects the new service to be up and running by the first quarter of next year.
Right now, asset managers represent a relatively small percentage of the daily volume on Hotspot FX, behind high-frequency traders, banks, hedge funds and commodity trading advisors (CTAs), Miesner said. “We recognize that the demand is there to provide asset managers a high-end service, particularly knowing that they already do an enormous amount of business in FX,” he said.
