1. Asset Alliance Corporation
Leaders in Alternative Investments
Demystifying Currency Risk
Elliot Noma
noma@assetalliance.com
Hedge Fund Risk Management
Nov 13, 2008
New York
Asset Alliance Corporation 800 Third Avenue, 22nd Floor New York, NY 10022 P. 212.207.8786 F. 212.207.8785 www.assetalliance.com noma@assetalliance.com
2. Currency Funds as a Diversifier
Correlation Matrix of Various Hedge Fund Return Indices
Currency managers historically have had low correlations with other hedge
fund strategies, preceded only by short-bias managers.
A B C D E F G H I J
A Barclay Currency Traders Index 1 0.28 0.17 0.12 0.38 -0.11 0.29 0.24 0.23 0.46
B HFRI ED: Merger Arbitrage Index 0.28 1 0.9 0.65 0.93 -0.79 0.88 0.93 0.96 0.44
C HFRI ED: Distressed/Restructuring Index 0.17 0.9 1 0.85 0.87 -0.62 0.88 0.95 0.97 0.54
D HFRI EH: Equity Market Neutral Index 0.12 0.65 0.85 1 0.6 -0.21 0.8 0.81 0.78 0.67
E HFRI EH: Quantitative Directional 0.38 0.93 0.87 0.6 1 -0.83 0.88 0.93 0.9 0.53
F HFRI EH: Short Bias Index -0.11 -0.79 -0.62 -0.21 -0.83 1 -0.61 -0.7 -0.71 -0.06
G HFRI Emerging Markets (Total) Index 0.29 0.88 0.88 0.8 0.88 -0.61 1 0.97 0.91 0.65
H HFRI Equity Hedge (Total) Index 0.24 0.93 0.95 0.81 0.93 -0.7 0.97 1 0.97 0.6
I HFRI Event-Driven (Total) Index 0.23 0.96 0.97 0.78 0.9 -0.71 0.91 0.97 1 0.51
J HFRI Macro (Total) Index 0.46 0.44 0.54 0.67 0.53 -0.06 0.65 0.6 0.51 1
2
† As of September 30, 2008. Source: HFRI, Barclay Hedge
3. Currency Managers move the Efficient Frontier
35%
30%
25%
20% HFRI Indices
15% HFRI Indices + Carry FX
10% HFRI Indices + Non-Carry FX
5% HFRI Indices + FX
0%
0% 2% 4% 6% 8% 10% 12%
3
† As of September 30, 2008. Source: HFRI, Barclay Hedge
4. There are a Wide Range of Currency Strategies
Managers A to F employ a mix of strategies
For managers AA to HH, carry trades make up a significant part of their
investment strategy
A B C D E F AA BB CC DD EE FF GG HH
A 1 0.62 0.47 0.28 0.23 0.1 0.18 -0 -0.5 -0.4 -0.4 -0.6 -0.8 -0.8
B 0.62 1 0.21 -0.2 0.41 -0.3 0.39 0.47 -0.4 -0.5 -0.3 -0.1 -0.1 -0.5
C 0.47 0.21 1 0.15 0.28 -0.4 -0.1 0.02 -0.3 -0.1 0.01 0.35 -0.3 -0.7
D 0.28 -0.2 0.15 1 -0.1 0.59 -0.1 -0.3 0.08 -0.4 -0 -0.5 -0.4 -0.3
E 0.23 0.41 0.28 -0.1 1 -0.4 -0.3 -0.2 -0 -0.1 -0.2 0.1 -0.2 -0.3
F 0.1 -0.3 -0.4 0.59 -0.4 1 0.32 -0 -0.1 -0.2 0.12 -0.5 0.2 0.19
AA 0.18 0.39 -0.1 -0.1 -0.3 0.32 1 0.8 -0.7 -0 0.32 -0.1 0.35 0.28
BB -0 0.47 0.02 -0.3 -0.2 -0 0.8 1 -0.5 -0.1 0.39 0.37 0.57 0.28
CC -0.5 -0.4 -0.3 0.08 -0 -0.1 -0.7 -0.5 1 0.06 0.23 0.13 0.17 0.23
DD -0.4 -0.5 -0.1 -0.4 -0.1 -0.2 -0 -0.1 0.06 1 0.39 0.31 0.14 0.32
EE -0.4 -0.3 0.01 -0 -0.2 0.12 0.32 0.39 0.23 0.39 1 0.61 0.56 0.41
FF -0.6 -0.1 0.35 -0.5 0.1 -0.5 -0.1 0.37 0.13 0.31 0.61 1 0.68 0.42
GG -0.8 -0.1 -0.3 -0.4 -0.2 -0.2 0.35 0.57 0.17 0.14 0.56 0.68 1 0.91
HH -0.8 -0.5 -0.7 -0.3 -0.3 0.19 0.28 0.28 0.23 0.32 0.41 0.42 0.91 1
4
† As of September 30, 2008. Source: HFRI, Barclay Hedge
5. Popular Currency Strategies
Carry trade
Cross currency arbitrage
Currency overlay
Macroeconomic
Central bank policy
Trade flows
Trend following
High frequency trading
Volatility trading
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6. Basics of the Carry Trade
AUD
JPY Sell 100 JPY
Buy 1.728 AUD
Invest in
Invest in
Australian
Japanese
Government
Treasury Bills Bonds
(coupon=.9%) (coupon = 7.5%)
12 months later:
Sell 1.8576 AUD Buy JPY
(breakeven exchange rate = 1.84)
6
† Source: Bloomberg
8. Return Patterns of Carry Trade Strategies
Profitability of the buy and hold carry trade strategy
October 2006 to October 2008
Long Basket Short Basket
Currency Weight Currency Weight
AUD 25% JPY 50%
TRY 25% CHF 50%
BRL 25%
140 NZD 25%
130
120
110
100
90
80
10/31/2006
12/31/2006
2/28/2007
4/30/2007
6/30/2007
8/31/2007
10/31/2007
12/31/2007
2/29/2008
4/30/2008
6/30/2008
8/31/2008
10/31/2008
8
† Source: Bloomberg
9. Carry Trade Monthly Returns
Distribution of monthly returns of the buy and hold carry
strategy October 2006 to October 2008
6
5
Frequency
4
3
2
1
0
-14%
-12%
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
9
† Source: Bloomberg
11. Cross currency trade
USD
H F uy
Se y 1
2C B
ll
Bu
93 .001
6 7 SD
. 56 1
1.1 1 U
50 U S
ll
JP D
Se
Y
CHF JPY
Sell 1.1672 CHF
Buy 93.5650 JPY
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† Source: Bloomberg
12. Disclaimer
This is the property of Asset Alliance Corporation.
No disclosure may be made to third parties regarding
any information disclosed in this presentation without
the prior permission of Asset Alliance Corporation.
This document has been provided for educational
purposes only. No representation or warranty is
made as to the accuracy or completeness of the
information contained in this document.
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13. Asset Alliance
The Americas Europe, Asia Pacific and the Middle East
800 Third Avenue 16 Charles Street
New York, NY 10022 Mayfair, London W1J 5DS
United States United Kingdom
T 212.207.8786 T 44.207.659.2900
F 212.207.8785 F 44.207.659.2901
info@assetalliance.com info@assetalliance-uk.com
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