By Nell Mackenzie

LONDON (Reuters) – Veteran hedge fund manager John Taylor describes one of his favorite Gary Larson cartoons, where a vulture sitting on an animal carcass says to another as others descend: “good friends who arrive from everywhere… it’s the best of times”.

There is, he jokes, a resemblance to the hedge funds currently surrounding the forex markets, where a sudden increase in volatility offers to boost returns for the few niche investors who have survived the quiet period. of a decade that forced many people out of the industry.

Taylor’s former company, FX Concepts, rode the market volatility of the financial crisis until its best year in 2008, when assets under management soared to more than $14 billion, making it the largest foreign exchange hedge fund in the world at the time.

But a post-crisis washout of central bank quantitative easing and developed-country interest rates barely above zero has undermined global currency markets by nearly $7 trillion a day of the kind of flow on which hedge funds thrive.

The so-called “carry trade” – where investors borrow a low-yielding currency and sell it back to buy a higher-yielding one – was wiped out, eventually leading to the demise of many such specialist funds, including FX Concepts after a 35-year streak.

Now, decades-high inflation is forcing central banks to raise interest rates aggressively again.

The US dollar hits 20-year highs as the Federal Reserve leads the tightening pack, the yen is at a 32-year low as the Bank of Japan, in contrast, sticks to its policy ultra-easy, and the pound hit record lows as government promises of unfunded tax cuts unnerved investors.

Volatility is back, and with it the kind of performance from currency funds not seen in years.

Deutsche Bank’s currency volatility index has jumped more than 100% so far this year and a BarclayHedge index that tracks the performance of currency hedge funds rose 5.71% in the first half, in good way to its best year since 2003.

Similarly, HFR’s HFRI 500 currency index, which also tracks these funds, is up 8.29%, its best performance since 2007 and sharply beating a 3.8% rise in a hedge fund index. wider.

Unable to resist the opportunities presented by the new inflationary environment, Taylor, at 78, has pulled out of his investment retirement to begin raising the funds he needs to launch a new hedge fund – typically 100 to 150 millions of dollars.

The trigger, he said, was listening to Fed Chairman Jerome Powell talk about inflation and the markets.

“No one has total power over the markets. The market goes where it goes. If he thinks he can (stop inflation and control the market), he will make a mistake.

Big players such as Brevan Howard, who also had a foreign exchange fund that fell victim to the post-financial crisis markets, have also been emphasizing forex. Its group of exchange-traded funds, BH Macro, has more than tripled its currency exposure over the past year and was up 18% at the end of August, according to a recent shareholder report. Brevan Howard declined to comment.

(BarclayHedge Currency Traders Index https://fingfx.thomsonreuters.com/gfx/mkt/gdvzyzebepw/BarclayHedge%20currency%20traders%20index%20performance.png)

ONCE BIT, TWICE SHY?

Years of low volatility wiped out existing hedge funds and deterred the creation of new ones, a process that typically takes 7-8 months.

According to BarclayHedge, fund liquidations and consolidations have far exceeded creations over the past four years, and no new currency-focused hedge funds have been launched this year, a first since the data provider began tracking. registers in 1990.

(Currency hedge fund launches and closures https://fingfx.thomsonreuters.com/gfx/mkt/xmpjozxqnvr/Hedge%20fund%20launches%20and%20closures.png)

Turbulent markets bring currency hedge funds out of a decade of slumber 7

A few held on. BarclayHedge estimates that there are between 85 and 110 such funds today, compared to 450 to 550 ten years ago. But they’re sitting on $1.3 trillion in assets under management, he notes, the most money entrusted to currency funds by pension funds, asset managers and wealth managers since the start of their records in 1990.

Still, currency trading is difficult, says Leslie Hill, CEO of Record Financial Group.

Record, which oversees $83.1 billion in assets, has become the world’s largest currency specialist by hedging the currency risk of asset managers’ more traditional portfolios alongside its own trading strategies.

It has a $4.5 billion currency fund and a $4.4 billion multi-asset fund, recent public disclosures have shown.

“Living on pure money, not just hedging – where the fees are low but the risks are high – but also money for yield…has driven many currency managers out of business,” Hill said. .

Adrian Lee, who founded Adrian Lee & Partners in 1999 and manages around $17 billion deployed simultaneously as hedge funds and currency risk management, believes conditions should remain soft for currency managers.

“Over the past 10 years as a currency manager, if you offered to add 2% upside to people’s portfolios while they were making 15% on their stocks, you wouldn’t get a peek” , did he declare. “Now the equity portion of the portfolio is losing money at the fist.”

Lee’s returns are just under 20% this year, said a source who could not be identified due to financial regulations.

While Taylor thinks a run on speculators could add to resurgent volatility, he argues that a recession will drive new lows for stocks and some bond and money markets — hedge funds or not.

Markets reflect the rhythm of an integrated cycle and traders are there to ride the wave, he said.

(Reporting by Nell Mackenzie; Editing by Kirsten Donovan)