Introduction to Trading Approaches

Diversify Your Portfolio with Foreign Exchange Investments

The foreign exchange markets offer investors the opportunity to diversify their portfolios from stock and bonds. Investors who diversify their portfolios, by including foreign exchange as an asset class, can lower the overall volatility of their portfolio. Stocks or stock indices even when varied by country or industry in your portfolio tend to move in synch.

The FX markets have a large variety of market participants compared to other capital markets, offering a unique opportunity for profit for motivated participants.

FX Markets Participants

A unique aspect of the foreign exchange markets is the large number of market participants that transact on a non-profit seeking basis. Professional investment risk-takers, dedicated to profiting from foreign exchange markets, only make up around 25% of market participants, as opposed to around 80% or 90% in other capital markets. The other market participants, such as central banks (which might intervene to enact government policy) and corporations (which typically transact to finance a specific deal), do not seek to generate profits as their primary motive for foreign exchange market transactions. Thus, the central tenet of the efficient market hypothesis is not as applicable in the FX market, and significant profits could accrue to profit-motivated participants. This was outlined in a recent study, performed by the Russell Investment Group ("Is there still Alpha to be gained in active currency management?" September 2003), which stated that currency market return opportunities not only exist but should be persistent due to the number of these non-profit seeking institutions.

This view is further supported by the evidence from consultant surveys and databases of currency fund performance, such as the Parker FX Index (graph below). Parker Global Strategies LLC, a U.S. company specialising in alternative asset placements, has published the Parker FX Index for nearly twenty years. Although market participants cannot invest in the index, it is seen as an inclusive and representative index of currency manager returns.
The graph demonstrates consistent, positive returns from the currency management industry over long periods of time. Another interesting feature is the lack of significant losses in the long history of currency investment. The average returns (net of fees and inclusive of USD funding) for the funds included in this survey are 10.3% per annum since 1990.