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Quants Find a Market Corner Where Value Trades Still Work

Todd White
·3 mins read

(Bloomberg) -- Trading stocks based on valuation has lashed some of the smartest stock traders on Wall Street, but it’s a winning formula in the world of foreign exchange.

A Bloomberg-Goldman Sachs Asset Management index that buys cheap currencies in the Group-of-10 and shorts expensive ones is up 5.4% over the past year -- trouncing measures that mimic strategies such as trend-following and the carry trade, which have dropped 3.7% and 7.6% respectively.

Valuation metrics are catching fresh attention in currency markets as investors abandon money-losing carry trades and search elsewhere for returns. The carry strategy, which involves borrowing in a low-yielding currency and investing in a higher-yielding one, is suffering anew as central banks around the world drive interest rates ever-closer to zero.

FX Value Beats Carry, Bloomberg-Goldman Sachs Asset Indexes Show

Foreign-exchange value strategies are commonly used by discretionary hedge funds and alternative risk premia funds, which manage an estimated $200 billion overall and seek to take advantage of longstanding market patterns. But there’s a wide range of methods that investors use to determine what’s cheap or expensive in foreign exchange.

For example, the Bloomberg-Goldman Sachs Asset Management index ranks a currency’s power to buy a basket of goods. It replicates a strategy of buying the currencies that have the lowest purchasing power, and shorting the ones with the highest.

Currently, the index is long on the euro, Canadian dollar and U.K. pound, and short the Norwegian krone and Australian dollar.

The dollar index’s decline from multiyear highs in March is one sign that investors are starting to factor in valuation, said Vasileios Gkionakis, head of foreign-exchange strategy at Banque Lombard Odier & Cie SA in Geneva.

“You have people looking deeper into valuing foreign currencies now because the hefty risk premium of the dollar started correcting,” he said.

Using value to trade currencies also beat stocks and bonds in the past year. The Bloomberg-Goldman index that uses a similar long-short strategy in equities plunged 21% in the past year. The one for bond futures only gained 3.4%, while the gauge for cross assets rose 4.2%.

“In a world where nearly all central banks have simultaneously cut rates, yields on carry baskets have collapsed to two-decade lows,” said Meera Chandan, global foreign-exchange strategist at JPMorgan Chase & Co. She’s bullish on the offshore yuan because it’s relatively cheap even after a recent rally.

Still, in a complex and highly financialized world, reserve currencies can famously defy fundamentals for years and trade on the basis of all manner of opaque market forces. Cheap currencies can stay cheap and expensive ones, like the Swiss franc or yen, tend to be elevated thanks to their status as a haven asset. In 2019, the Bloomberg GSAM FX Carry Index rose 6.5%, twice as much as the value gauge.

(Adds cross-asset comparison in ninth paragraph)

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