Active Currency Investing and PerformanceBenchmarks

Abstract

No established benchmarks currently exist for evaluating a currency manager’s performance. Some analysts have suggested that known investing styles, such as momentum, purchasing power parity, and carry, can serve as bench-marks, but this approach has several challenges. First, there is no market portfolio. Second, there are many alternative generic factor constructions. Third, different constructions of the same factor may have low correlations. Fourth, the three factors may not provide diversification, and lastly there is no buy-and-hold in the foreign exchange market. An evaluation by Melvin and Shand indicates that professional currency managers’ returns are often generated independently from the generic style factors. Skill in timing is what investors should pay for and some managers demonstrate superior skill in timing the factors. Managers are also skilled at minimizing drawdowns relative to the generic factors. The authors conclude that the use of generic style factors may be a worst-case scenario instead of returns to which a foreign exchange investor may aspire. <b>TOPICS:</b>Performance measurement, manager selection, currency