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Analyzing more than 200 unique fund products that have a primary investment strategy focused on foreign exchange markets, the HFN Strategy Focus Report – Foreign Exchange Strategies, showed that that total hedge fund assets invested in FX strategies were $51.6bn at the end of Q1 2011.

However, early data from May is showing early indications that the group lost most, if not all of April’s gains.

“Performance from FX strategies in April and May indicate the aggregated positions from the group were negative on the U.S. dollar. The correlation of monthly returns of FX strategies to a U.S. dollar vs. basket of currencies index in the last two years was -0.62. However within the FX universe there is a diversity of strategies which make the aggregation of return streams an opaque image of individual success and failure,” the report stated.

Going forward
As a general rule for the whole hedge fund industry, investors chase returns. A study by HFN showed that investors tend to get rewarded for chasing returns and rewarded for redeeming from funds which underperformed, at least in the years following the financial crisis. The first part of the trend holds true for FX strategies.

Funds reporting full asset streams to HFN which had negative returns in 2010 have had an average of $19m redeemed in the last nine months and an average of $4m in 2011.

Those that outperformed the hedge fund industry in 2010 had average net inflows of $26.1m in the last nine months and $10m in 2011. Investors have appeared to make decent decisions as well. The bottom group is -0.12% in 2011 while the top group is +3.73%.

The above figures do not speak well for FX strategies as a whole. Given the relatively poor aggregated performance in 2011 (only one-third of FX funds have outperformed the industry in 2011 through April, a figure which will likely shrink in May) the strategy will likely continue to reduce in size with money flowing to a select group.

FX fund characteristics
The majority of forex hedge funds are located in the U.S., especially in New York, Chicago and Boston. But London remains the most common city in which FX strategies base their operations.

On the average, FX strategies run $228.5m in assets, compared to the average equity strategy size of $201.2m and average fixed income strategy size of $443.5m. The majority of the current crop of FX and credit funds were launched in 2008 while equity fund launches peaked in late 2006 and 2007.

More importantly, the study found that London and the rest of Europe have a higher concentration of quantitative based FX strategies while in the U.S., Boston and Chicago have more discretionary based strategies than New York.

Performance by size
Returns by strategy assets differ slightly. FX entities appear to have a higher concentration of managed accounts and so actual fund size may not be the best indication of the size of an FX operation. The study concluded the following based on performance by size and strategy:

• Smaller FX funds had a slightly higher median return than larger funds, yet larger funds ( more than $100m) had meaningfully higher top percentile returns.
• Large FX strategies (by “assets in strategy”) have performed relatively well in the last twelve months and YTD 2011.
• The FX entities, by strategy AUM, with greater than $1bn returned an average of +16.45% in the LTM and +5.47% in 2011; both above the broad hedge fund industry aggregated returns.
• Based on the multi-sector funds that utilize FX strategies either primarily or secondarily, it appears that FX strategy exposure in general has been a drag on performance.
• In recent terms, there has not been a meaningful difference between quantitative and discretionary FX strategies, but over the longer term, funds which allow for a discretionary influence have done better.

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