Integrated Approach to Currency Factor Investing

Abstract

Using the G10 universe of currencies, we evidence that parametric portfolio policies can help guide an optimal currency strategy when tilting towards cross-sectional factor characteristics. While currency carry serves as the main return generator in this tilting strategy, the two characteristics momentum and value are implicit diversifiers to potentially balance the downside of carry investing in flight-to-quality shifts of FX investors. Drawing insights from a currency timing strategy according to time series predictors, we further examine the parametric portfolio policy's ability to mitigate the downside of the carry trade by incorporating an explicit currency factor timing element. This integrated approach to currency factor investing outperforms a naive equally weighted benchmark as well as univariate and multivariate parametric portfolio policies.