By Jemima Kelly
LONDON (Reuters) - Big price swings in the foreign exchange market are back and currency funds are reaping the benefit after years of poor returns as central bank cash suppressed the volatility on which they depend.
Laith Khalaf, a strategist at investment group Hargreaves Lansdown, said he could not recall a month since the 2008 financial crisis when a currency fund was in the top 10 of the more than 2,000 funds the firm tracks. In September, there were two in the top five.
And an index of global currency managers' performance, the Parker Global Strategies CMI-C Index, posted a 2.63 percent rise in September, its biggest monthly gain in 10 years. The index has lost money in four out of the last five years.
Currency funds, which make up just a tiny proportion of the $70 trillion (43.36 trillion pounds) asset management universe, bet on the direction of exchange rates. But currency movements must be decisive enough to enable investors to ride trends and make decent returns.
"Higher volatility gives you the opportunity to capture dislocations in the market, between what the market is pricing and what the fundamentals are telling you," said Ugo Lancioni, head of currency management at investment firm Neuberger Berman.
Having languished at record lows until the middle of this year, volatility in the foreign exchange market rose sharply in the third quarter, as a long-forecast rally in the dollar materialised and the U.S. Federal Reserve wound down its $4 trillion bond-buying programme.
Insight Investment's Paul Lambert, who runs the third-best performing fund tracked by Hargreaves Lansdown for September, the Absolute Insight Currency fund, said the return to volatility would be long-lasting, as monetary policy in the world's biggest economies increasingly diverged.
"Having been quite dull for a long time, things have started to perk up a bit and happily we've been on the right side of it," said Lambert, whose $300 million fund grew 4.23 percent in September, the most in six years, on bets the dollar would outperform the euro and its Australian and New Zealand counterparts.
"That phase we were in for a very long time of extremely depressed levels of volatility is probably over."
But though the outlook may now be brighter, some currency funds have not managed to stay afloat. FX Concepts, once the world's largest foreign exchange fund with $14 billion in assets under management at its peak, filed for bankruptcy last October after a slew of withdrawals due to a run of poor performance.
BEATING BETA
Unlike an equity or fixed income fund, in which it is possible to rely on "beta", riding on broad market moves to produce returns, currency funds must play a risky zero-sum "alpha" game: either they correctly predict the direction of exchange rates and win money, or they do not, and they lose.
Since the global financial crisis bit in 2008, central banks, most notably the Fed, have buoyed asset prices by injecting liquidity into the market through cheap loans, record low interest rates and the printing of money, allowing stocks and bonds to perform exceptionally well.
"You had a situation where the absolute opportunity (for currency investors) was more difficult because volatility had been suppressed and the way returns appeared on a relative basis was more depressed because everybody else's returns had been boosted by central banks," Lambert said.
But now that liquidity is being reeled back in. The Fed is due to pump the last $15 billion of its quantitative easing programme into the U.S. economy this month, and with bond yields at record lows and stock prices looking stretched, investors are likely to seek alternative sources of income.
Like other alternative investments, currency is seen as a good way to diversify portfolios because of the lack of correlation between currency prices and those of more traditional assets - stocks, bonds, and cash.
Lambert said he has seen a sharp pick-up in enquiries into his currency fund over the last quarter by both institutional and private investors.
"It is a good time to be a currency investor," said Lancioni. "Currency is coming back."
(Reporting by Jemima Kelly; Editing by Peter Graff)