Tight Currency Ranges Put Pinch On Forex Funds

Dow Jones, March 27, 2006

With key currency pairs trapped in tiny ranges so far in 2006, the environment for forex funds has been tough.

Many funds have struggled to make money as clear trends have repeatedly failed, leaving returns from the forex fund community as a whole roughly flat as the end of the year's first quarter looms. Some even appear to be turning their backs on currencies for now.

But it's not all bad news. Short-term funds have been able to avoid losses and even to eke out respectable returns, helping to deflect attention away from the big trend hunters.

And there's still a fighting chance of a breakout from here - a development that could supercharge the whole sector.

"I don't think it's that bad. There are a few people having a really hard time, but most people are hanging in there," said George Dowd, vice president of Chicago-based Spectrum Asset Management, which runs a currency fund that invests on short time horizons.

"Every year, there are three or four months where you make all of your returns for the year, so it's not overly concerning."

Some peripheral currencies like the New Zealand dollar and the tiny Icelandic krona have made spectacular losses so far this year, falling by 12% and 16% against the dollar respectively.

But key pairs like euro-dollar, dollar-yen, sterling-dollar and dollar-Swiss franc - favored by many currency funds because of their greater liquidity - have been ticking around in tiny ranges since the start of the year, and indeed in some cases since October.

Although a big dollar drop, based on external imbalances or, more likely, on cyclical factors, is seen as highly likely in the second half of the year, there are few signs that the market has an appetite to push the greenback down just yet.

Some analysts see the dollar gaining more support later this week when the Federal Reserve announces its rate decision - a key factor in supporting the currency.

"The dollar would rally on any signs from the Fed that they still see inflation risks biased to the upside," said Monica Fan, global head of currency strategy at RBC Capital Markets in London.

A bout of renewed dollar strength, unless it's dramatic, would keep those ranges in place. So watching and waiting is all that some funds can do for now. "You keep your powder dry," said Dowd.

The springtime lull is reminiscent of the sleepy days of summer, when currency markets are often becalmed.

"It looks a lot like August," said Glenn Stevens, managing director at Gain Capital Group, a Bedminster, NJ-based firm that offers foreign exchange trading services and runs two currency funds.

"One of the reasons for that is that globally, we're at a few inflection points," he said, alluding to big moves that could yet come from the dollar, the yen, and the yuan later this year. "When we're at these inflection points, that's when the market pauses."

In other words, this could be the calm before a storm.

The impact of the current pause is that around half of the funds that participate in Deutsche Bank AG's (DB) FXSelect platform are posting losses, albeit generally small losses, so far this year.

There are even some signs that speculative accounts such as hedge funds are turning their backs on currencies for now. Last week, positioning data from the Commodity Futures Trading Commission showed a marked pullback in open interest in currencies contracts for the second week in a row.

"Speculators may be growing frustrated with FX and turning to other asset classes," said Peter Frank, a currency strategist at ABN Amro in Chicago.

But in a sign of how much the currency fund space has matured over the past two years, and how many different trading styles are now used in this market, it's notable that there's a broad mix of performance within the asset class.

Torquil Wheatley, a director of client strategies and solutions in the currencies business at Deutsche Bank, notes that the other half of the funds on FXSelect are posting flat-to-positive returns for the first two months of the year. Eight of them are up by over 2% and one is up by over 7%.

So far this year, "the best performers have been the short-term players and the short-term trend followers, particularly those that use a mixture of systems," Wheatley said. "It has been the long-term players that have had a hard time."

Dowd's Spectrum fund, which generally holds its positions for five to 10 days, is up by around 2% since the beginning of the year - a good start for a fund that makes average annual returns of just under 5%.

Similarly, Gain's currency funds, which use a mixture of strategies, were roughly flat at the end of the first two months of the year. "It's a question of style, and it's hard for the big macro guys to adjust," said Stevens.

But those so-called macro funds, which latch on to much longer-term trends to make their returns, are still expected to make a comeback.

"You are going to see the longer-term guys outperform again," said Dowd. "As far as performance goes, 06 will be a good year. I think as we go into May and June through to year-end there will be some nice trends developing. That will help the community and how much money is coming in."