Institutional Investor's Alpha Magazine - November 2007 - (Page 28)

Bill Lipschutz banks of trade-surplus nations, such as China, Russia and the OPEC members, as well as sovereign wealth funds chasing higher returns through non-dollar-denominated offshore investment. At the same time, pensions and endowments want to segregate and actively manage the currency component of their non-base-currency assets, and global macro hedge funds are looking to put money to work in the enormously liquid currency markets. Which currencies do you trade? with the Federal Reserve Board aggressively cutting interest rates in response to the still-unknown effects of the credit dislocations of the past several months, the market is in full dollar-sell mode. But the wrinkle is that those unknowns have also inspired higher volatility across all asset markets and a heightened sensitivity to risk aversion. As a result, some currency market participants are less eager to hold carry trades and are selling high-yielders, such as the Aussie dollar and the Kiwi dollar. How do you manage rapid market change? We only trade G-10 currencies, because they are the most continuously liquid, both in spot and in options. Australia, Japan and the Eurozone have transparent, stable and wellﬂagged economic and political policies. Emerging-market economies are often more opaque and less stable. Why do you use options to trade foreign exchange? Often there is an advantage to being a discretionary trader: We can move more nimbly when things change rapidly. We are very quick to see market sentiment shift and are primed to take immediate action. What has been the impact of the recent equity market turmoil on foreign exchange trading? “When markets are nervous, as they have been since the middle of the summer, G-7 meetings take on even greater importance.” We generally buy options and combinations of options to express basic trade ideas and build basic positions. This approach offers superior risk-return characteristics to buying the actual currency pair or spot — also called cash — outright. It also has a built-in risk management system; you can lose only what you put up. As well, there are often pricing inefficiencies in the options themselves that we can proﬁt from. What governs your investment process? Global stock markets have recently been looked to as indicators of global markets participants’ willingness to take on risk. When these markets are under pressure, currency traders tend to want to cut riskier positions, such as the carry trade. What factors are triggering risk aversion? Many global stock markets are near all-time highs, while the U.S. housing market is collapsing, mortgage lenders are going bankrupt and banking institutions around the world are writing down billions of dollars’ worth of assetbacked paper. This is not a stable situation. In this environment, many investors are simply cutting back on exposure and moving to cash. How do general ﬁnancial worries affect currencies? We are primarily directional in nature. While we look to positions based on a view of one currency’s appreciating or depreciating against another, we — BILL LIPSCHUTZ are constantly seeking fundamental bases for a currency pair to move. As a user of long options, we are generally long volatility as well. We will proﬁt from instability. Often we are positioned not for a move up or down, but for a move in either direction. Where do your trading ideas come from? Currency traders are aware of the heightened uncertainty surrounding unknowns such as the extent of the credit problems in the U.S. and other countries. They also understand that any new headline could cause an abrupt change in market sentiment, and they’re ready to commit huge amounts of capital almost instantaneously in response to such information. How do these rumors inﬂuence your trading? We are discretionary traders, which means we develop two views of the world. The ﬁrst is a macro view — the big picture. We absorb all kinds of information regarding world events, macroeconomic factors and global political developments. We also look at the micro environment, called “being close to the market.” We work the phones day and night; we talk to traders, salespeople and economists at major banks and to other hedge funds. At all times we want to know what the market drivers are — what’s moving a currency pair? What is driving the currency market now? In a nervous macro environment, headlines and rumors take on a life of their own. As the market absorbs information, large currency moves may be generated. This in turn can force the hands of participants holding what have now become the wrong positions, even if they believe the new information is false or unimportant. In such cases the market will reduce risk exposure by nonselectively cutting positions. Why has the U.S. dollar been falling? The currency market is focused on global imbalances, and 28 • INSTITUTIONAL INVESTOR’S ALPHA • NOVEMBER 2007 The official line from the U.S. Treasury is that a strong dollar is in the best interest of the U.S. and that FX rates should be set in a free and open market. Although that has been the mantra of the U.S. Treasury since Robert Rubin took charge during the Clinton administration, most play-

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - November 2007

Institutional Investor's Alpha Magazine - November 2007 Contents Letter from the Editor Longs & Shorts Pension Corner: Patriot State The Good Guys: College Connection Interview: Currency of Change Cover Story: Comeback Kid Strategies: Masters of Art Research Center: Alpha Awards: Top Technology Providers Top Analysts Alpha Bytes: Critical Choice Unhedged: Commentary: Banking on a Bubble

Institutional Investor's Alpha Magazine - November 2007

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