Would anyone be happier to see a single-currency world than global investment managers? Probably not. There is nothing more frustrating than seeing the hard work of individual asset selection and portfolio creation negated by currency fluctuations.
Like it or not, all investors are currency speculators. For example, Americans investing overseas in 2003-2004 benefited from dollar weakness, only to be harmed by dollar strength in 2005.
Worse, both portfolio managers and individual traders have to face the problem of which currency (or basket of currencies) to use if they decide to hedge their investments. A second and equally daunting question then comes into play: Should you hedge actively or passively that is, should you try to trade or simply offset your initial currency exposure?
The annual returns of the Barclay Currency Traders Index are instructive in this regard. Like all hedge fund indices, this barometer has a massive “survivorship” bias. That is, the index sheds its laggards and retains its winners for each succeeding year, skewing the results in favor of the funds that survive or outperform rather than reflecting the performance of funds that blow out or underperform. (In fairness, the same can be said of stock indices.)
The compound annual rate of return (ROR) for the Currency Trader index has been 10.12 percent, with a Sharpe ratio of .41. (For comparison, the average annual returns for the Merrill Lynch 5-10 Year Treasury index and the S&P 500 were 7.54 percent and11.46 percent, respectively, over this same period.) Because active management has a higher cost and greater variability of returns, we will turn our attention to a passive currency hedge management approach.
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