Wednesday, October 17, 2012

Synopsis of FX Invest West Coast 2012

FX Week held its second annual FX Invest West Coast Conference on September 11, 2012 in San Francisco.  I attended this investment conference on currency last month.  I've had a lot of work to catch up on since then and this report is one of those things I stuck on the back burner.  Well, better late than never.  I publish according to my schedule, no one else's.  The month since then has given me plenty of time to absorb the conference material and figure how much of it applies to my own portfolio.

I missed the first couple of speakers due to a breakfast meeting with some visiting executives, so when I arrived late I wasn't able to secure a seat next to some of the hot chicks in attendance.  There weren't that many chicks anyway so pickings were slim.  I slid into a vacant seat near the front after listening to one hot chick, Lida Preyma of the G20 Research Group, give her rundown of the European debt crisis.  She thinks Greece won't be allowed to leave the euro due to the chaos that would ensue, and even Germany's objections would not be sufficient to forestall ESM implementation.  She's correct so far but 2012 isn't over yet.  I had the chance to talk to her afterwards and she's even hotter when viewed up close.

A panel of managing directors from institutional investors like State Street and Mellon Capital held forth on whether the US dollar still was the healthiest currency on tap.  I could have told them it wasn't but they didn't ask me; those firms never responded to me when I sent them my resume years ago.  Anyway, they said the Canadian dollar looks good because the central bank up there in the Great White North is unlikely to do QE.  That 's good news for people long FXC (like me).  They correctly predicted QE3 here in the US, which in hindsight was a no-brainer (I saw it coming too, if you read my previous blog posts).  The panelists said something really dumb by claiming the US dollar would lose its bull case if the US Treasury issued bonds denominated in euros.  Come on, why would they do something so pointless?!  Even Robert Rubin's proteges at Treasury aren't that dumb.  There is no point in issuing US treasuries in euros in the face of that currency's likely self-destruction just because it's a more widely held currency than Canadian, Australian, or New Zealand dollars!  If the US was to issue securities in foreign currencies, those would be the more likely candidates IMHO.  The panel was somewhat prescient on other things despite this one stupid comment, noting that governments' stimulus has had no success channeling money into real economies due to low demand for funding and tight credit requirements.  I say just wait until the US government starts forcing banks to lend.  One very revealing observation was that European governments have no real plan to either forestall or manage a eurozone breakup, and their actions to date hint at hidden panic among policymakers.  I figured that out earlier this summer, after watching US Treasury Secretary Timothy Geithner's shuttle diplomacy force Germany's Angela Merkel to take a more pro-euro public stance.  Despite all of this blather about the euro, the panel never really addressed the health of the US dollar in detail aside from stating that QE3's impact would be limited and the Fed would be out of ammo (hey, they've been correct so far).  When I'm on one of these panels at next year's FX Invest West Coast Conference, I'll tell them all about how serious inflation is just raring to go in the US.

You know something, I'm still quite fond of my concept of a "Holy Roman Euro." I mentioned it to Lida Preyma while I was flirting with her during a break and she seemed intrigued.  Of course, attractive women can't help but be intrigued by the extraordinary greatness that is Yours Truly, Anthony J. Alfidi.  I believe France, Germany, and the Benelux region were meant to be permanently linked financially due to their cultural and physical connections.    They have more in common with each other than they do with Southern Europe.  The Holy Roman Euro will fulfill the original mission of the European Coal and Steel Community - preventing war in Western Europe.

Legendary currency quant analyst Jessica James was up next to talk about FX options and equity as drivers of FX moves.  Currency options intrigue me as an indirect way to borrow in low-interest currencies and go long in high-interest currencies.  Dr. James discovered that FX option payouts vary significantly from premia paid, implying great opportunity for investors.  Systematically writing straddles since 1986 would have been a very successful trading strategy.  Her discussion of implied volatility and the implied rates of currency pairs brought back memories of my MBA global financial instruments elective, and thankfully I still have my notes and can apply the hedging strategies I learned.  Note to self:  Long-dated options have higher premia with a sweet spot for value at the one-year point (thanks, Dr. James).  She noted that customers' equity positions tracked by the World Federation of Exchanges have increased recently.  Her discovery implies that a good trading strategy is to buy the short-term forward contract of an FX pair after buying equity, but I wonder . . . equity domiciled in which country?  Denominated in which currency?  In other words, would you pair the Hong Kong Dollar with Chinese equity?  Her brilliant research shows how equity investment flows drive FX moves, which makes intuitive sense once you realize that FDI has to be exchanged for local currency at some point in the transaction.  Money managers can develop hard-core hedging strategies with Dr. James' research.

Now we come to another panel before lunch.  This group talked up the latest developments in electronic trading for the buy-side community.  I found this discussion of platforms to be extremely boring and not at all germane to my portfolio.  My impression of the sector is that customers who need currency constantly exchanged (import/export firms, ocean carriers) would prefer platforms emphasizing speed of execution.  Customers who focus on long-term hedges (manufacturers buying capital goods) would prefer platforms offering best price.  Anyhow, the panelists kept boring me to death but I picked up some nuggets of info despite my eyes glazing over.  Banks make up 99% of the currency market's liquidity providers and market makers, so FX platforms are banks' liquidity enablers.  Unbundling services cuts premiums and adds value for buy-side clients (hey, that makes me think of cable/satellite TV providers unbundling their channel packages, of all things).  These folks claim that unbundling increases transparency but I'm not convinced.  IMHO only seeing a counterparty's posted collateral can do that.  No wonder I have a hard time taking platform technology seriously, as it is not at all a panacea for counterparty risk.

Lunch was served.  I was impressed with the spread at the Hilton San Francisco Union Square, with great risotto and plenty of meat offerings. The Hilton's "vine spritzer" drink was some kind of sparkling grape juice concoction.  Some e-platform sales jerk with an Australian accent grabbed my napkin to wipe his fingers.  I restrained my impulse to slug him even after he had the nerve to start pre-qualifying me as a prospect.  I don't get angry at investment conferences because I want to be invited back.  My extremely stern facial expression must have told him that I was not in the mood to be trifled with given his rudeness.  He walked away and I grabbed his dessert, some really nice chocolate truffles.  I'm all about justice.  I grabbed even more dessert later on because the pickings were so good but my waistline doesn't suffer because I work out more than most finance slobs.

A manager from CalPERS gave the afternoon keynote on standards for calculating currency returns.  Why hasn't this been done yet?  Well, maybe because money managers compare returns in a single currency (like the dollar) and not in a universal standard like the information ratio.  I don't buy his argument for a "risk budget" because IMHO there is no truly riskless approach in currency.  I also can't buy his advocacy of using Libor as a credit component because it's been totally discredited by this year's bank manipulation scandals.  I'd rather use the long-term interest rate of the nation underlying the short component of the currency pair in question (i.e., the ten-year Treasury for the US dollar).  I also noticed that levered portfolios don't seem to add much alpha.  My bottom-line takeaway from this one is that if currency positions are identical as a percentage of a portfolio, then choosing your base asset (Libor vs. T-bill) will change the interest rate you use as a metric of a manger's skill.  That in itself heavily influences a currency portfolio's ROI, perhaps even more so than the currency's beta.

The next panel talked about winning investment strategies.  One of the panelists earned my permanent enmity when I met him at the first FX West Coast in 2011, when he insulted my intelligence.  I didn't rip his head off then and that's why I got invited back this year.  The panel spewed a bunch of nonsense that told me they learned nothing about benchmarks and risk budgets from the previous speaker.  One telling comment did slip out:  "Good times make us all carry traders, bad times make us all hedge traders."  There has never been a more complete indictment of the futility of a currency-only investment strategy than that revelation right there.  Listening to these pedigreed fools convinced me more than ever that currency holdings should hedge the cash portion of a domestic portfolio and should not be pursued for the sake of their own ROI.

The next speaker on risk management said that institutional investors, especially plan sponsors, need to match assets to their liability streams, and currencies are no exception since they are assets that produce long-term non-zero returns.  Alpha is possible if two funds with different risk profiles engage in currency swaps.  The more I think about that, the dumber I think that would be but fund managers can be pretty dumb.  Here we go again with pursuit of currency ROI for its own sake, rather than putting currency investing in its proper context of hedging cash holdings or FDI transactions!  This insanity is going to come to a screeching halt when central banks pull the leverage rug out from under money-center banks, or if hyperinflation forces the repeal of legal tender laws.  Yeah, currency geniuses, try that on for size.  I did agree with the guy that said the currency of a high-inflation country should fall in value; I mean, come on, that's obvious.  He noted that currency bid/ask spreads exploded after the Lehman Brothers collapse in 2008.  I noted that a lot of these pros use "GFC" as shorthand for the Global Financial Crisis but they seem to think it's over.  Fat chance.  His final comment that euro-sovereign risk is baked into every market right now was yet another Captain Obvious moment.

The next speaker was a currency advisor from Credit Suisse with a very informative presentation on volatility regime classification.  It's the kind of thing that would bore most people to death but there's a chance it would add value as an approach for a global asset manager who needed a currency overlay to manage exposures in multiple countries.  His conclusion was that conditioning your trade strategy selection on the type of "regime" you're in will improve risk-adjusted returns.  The regime itself has two dimensions:  a vertical axis for volatility (low to high) and a horizontal axis for term structure (flat to steep).  The only problem I have with this kind of thinking is that these regimes do not persist over time, and the discontinuity that occurs when one regime suddenly changes into another (i.e., the term structure of interest rates suddenly steepens when a central bank buys the short end of a yield curve) will probably invalidate a manager's strategy.  Making this work as a money management strategy means staying very liquid if regimes change quickly in a day.  Violent transitions will make you lose money and get you fired.  In other words, this kind of thinking is the financial equivalent of a Rube Goldberg mechanism for selecting currency investment strategies.  IMHO, the best currency strategy is the simplest, one that hedges cash exposure.

Another speaker heralded the end of "beta trading" baskets of Asian currencies.  The yuan's appreciation and the likelihood of a persistent structural deficit in China's capital account spell the end of an era.  His claim that Asia will be a currency safe haven is too simplistic for me to take seriously.  Come on, dude, your thesis only considers capital and current account flows.  You're completely ignoring debt/GDP as a solvency metric, interest rates, and the propensity of central banks to favor inflation!  What a stupid FX strategy!  I can't believe people give this guy money to invest.  BTW, I also noticed quite a few people at this conference spending perfectly good money on Starbucks coffee from the lobby even though the hotel provided us all with endless free coffee (I'll say it again, FREE OF CHARGE java) with our meal and snack breaks.  The behavioral finance implications of my discovery fascinate me to no end.  The people attending FX West by and large are accustomed to throwing away money, and it appears their clients are equally willing to throw away money by letting these people manage it with Rube Goldberg currency strategies.  There are so many suckers for me to have as counterparties in the investing world.  It boggles my mind that these people can dress themselves in the morning.

One thing I need to mention before I touch on the final panel is the word of the day:  leptokurtic, or a distribution with a higher peak around the mean than a normal distribution.  Speakers used it to describe the distribution of currency returns.  I'll use it to describe the distribution of intellectual ability among currency portfolio managers, i.e., there are a lot more average Joes doing this work than you'd expect and far fewer superstars.

The final panel talked about the global outlook for currency investing.  I couldn't take my eyes off this one hot chick on the panel, Natalia Gurushina of Roubini Global Economics.  She was one hot blonde Russian with knee-high boots that unfortunately hid her legs from view.  Anyway, they said that "frontier currencies" represented an uncorrelated asset class in theory; I say it's because political instability makes it hard for a frontier economy to ever cross the threshold into the emerging market realm.  One panelist opined that quants like them are reluctant to call this low-growth era the "new normal" because it will invalidate all financial models based on recent history.  Well, no duh!  That admission made me realize that these people are all hard-core quants who find Buffett-style fundamental analysis incomprehensible.  I find their collective professional existence to be one of the greatest misallocations of intellectual effort in human history.  These people have no idea how badly they need me as a speaker next year.

The conference closed up and cocktails were served next door.  I made sure to eat enough cheese and crackers to suffice for dinner.  I couldn't resist the chance to ask one of the attendees about his history with one of the backers of the Blueseed idiocy, which you'll recognize as a completely unworkable concept if you read my articles on it from many months ago.  This guy pretty much confirmed my thesis that it was a stalking horse for a hidden agenda, one that is more focused on collecting business plans than launching a high-seas adventure.  Folks, I can figure all of this stuff out myself.

I enjoyed this conference to no end.  It made me feel okay that none of the big firms here had ever considered hiring me, because I would have had to swallow a lot of overcomplicated nonsense just to hang onto my job.  I couldn't do that at firms that did hire me and they showed me the door.  Now doors open to me because I can write persuasively about stuff these people miss.  I'll return to FX Invest West Coast next year and I'll find some more hot finance chicks to bring along.