Forex Funds and Managed Accounts are Popular Alternative Investments.

Forex funds and managed accounts have become popular alternative investments. The term “Alternative Investments” is defined as investment securities trading outside traditional investments like stocks, bonds, cash, or real estate. The alternative investment industry includes:

  • Hedge funds.
  • Funds of hedge funds.
  • Managed futures funds.
  • Managed accounts.
  • Other non-traditional asset classes.

Investment managers are known for their ability to deliver absolute returns, despite market conditions. Using strategy-driven and research-backed investment methods, alternative managers try to provide a comprehensive asset base and benefits such as less risk through lower volatility with the probability of improved performance. For example, currency funds and managed account managers are in the business of delivering absolute returns regardless of how the traditional markets, such as the stock market, are performing.

currency-hedge-fund

Forex fund manager’s performances will not be correlated to any of the conventional asset classes listed above. For example, if the US stock market is down, most US equity advisor’s performance will be down. However, the direction of the US stock market will not affect a Forex fund manager’s performance. Consequently, adding a currency fund or managed account to a portfolio of traditional investments, such as equities, stocks, bonds, or cash, is an excellent way to diversify a portfolio and potentially decrease its risk and volatility profile. 

The Trouble With Forex Track Records

Forex Track RecordThe trouble with Forex track records is that they are challenging to verify.  One easy way to confirm a track record is by giving it a “common sense” audit.  Ask yourself these two simple questions:

1. Does the Forex track record deviate from the average track record of other well-established funds?

2. Is the record too consistent over time relative to other programs whose records are verified and audited?

If the manager of a Forex fund or managed account program states  “my program is up ++20% per month for the last 12 months!”; you can be almost 100% sure that the manager is lying, or he has only a few hundred dollars under management, or it is a proprietary trading operation that does not need the public’s investment dollar.

The Sharpe Ratio and Risk Adjusted Performance

The Sharpe ratio is a measure of risk-adjusted performance that indicates the level of excess return per unit of risk in a Forex Funds returns. In calculating the Sharpe ratio, the excess return is the return over and above the short-term, risk-free rate of return, and this figure is divided by the risk, which is represented by the annualized volatility or standard deviation.

Sharpe Ratio = (Rp – Rf)/ σp

In summary, the Sharpe Ratio is equal to the compound annual rate of return minus the return rate on a risk–free investment divided by the annualized monthly standard deviation. The higher the Sharpe ratio, the higher the risk-adjusted return. If 10-year Treasury bonds yield 2%, and two Forex managed account programs have the same performance at the end of each month, the Forex managed account program with the lowest intra-month P&L volatility will have the higher sharpe ratio.

Risk graph with dollar sign being cupped by a man's hands.

The Sharpe Ratio is an important risk management metric for investors to understand.

The Sharpe Ratio is most often used to measure past performance; however, it can also be used to measure future currency fund returns if projected returns and the risk free rate of return are available.

At A Glance: Forex Managed Account Track Records

Not too long ago, a trader asked me to review his track record, but I only had 5-minutes to do the review.  Is it possible to examine a track record in five minutes?   The answer is: yes. It should just take a few minutes to analyze a well-documented Forex track record*.

Unfortunately, most track records are poorly organized and difficult to glean any information from regardless of how long the reviewer has to peruse the trade statistics.  Well-organized track records will tell the reviewer the following (not listed in the order of importance):

  1. The Forex trader’s name,  location and the name of the program.
  2. Regulatory jurisdiction.
  3. Brokers name and location.
  4. Amount of assets that are under management.
  5. Peak to trough draw-down.
  6. Length of the trading program.
  7. Month by month returns and  AUM.

The Challenges of Investing in Emerging Forex Traders

Investing in emerging Forex traders (these traders are sometimes called managers) can be extremely rewarding, or it can be extremely disappointing.  Similar to athletics, catching a rising star before anybody else notices a person’s talents can be financially rewarding for both the discoverer and the discovered.  Generally, as assets under management grow, returns shrink. And here’s the paradox: the longer you wait for a emerging Forex trader’s track record to become statistically significant, the more likely it is that that manager is going to acquire more assets under management and the managers track record will suffer due to the law of diminishing returns. Forex fund investors know it is easier to manage a $100 thousand than  $50 million.

Emerging Forex Trader

An emerging Forex trader trading looking for trading opportunities. 

Investors who take that first chance on emerging trader can make a fortune.  The initial investors in Warren Buffet and Paul Tudor Jones funds are now multimillionaires, or possibly billionaires.  How an investor picks an emerging manager is as much of an art as it is the science.

The art and science of picking emerging currency traders will be a topic of Forex Funds blog post shortly.

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