Have currency traders been successful in exploiting their exchange rate forecasts?

What will be an ideal response?

While there exists scant empirical evidence on the forecasting ability of exchange rate forecasting services, the number of active currency traders, mostly organized as hedge funds, has grown considerably over the past decade. Because many of these currency traders report returns to various indices, we can analyze their performance. If such funds fail to forecast exchange rates, they should not consistently produce high returns! Pojarliev and Levich (2008) conducted a study on the returns earned by currency managers reporting to the Barclay Currency Traders Index (BCTI) between January 1990 and December 2006 . All of these returns are reported net of fees. Hedge funds typically charge a fixed fee of 2% and a variable fee of 20% on the performance over a benchmark (which can be zero or the Treasury bill return). The study first tries to establish what techniques the currency managers use: Do they use the carry strategy, do they follow trends, or do they trade based on fundamentals? To do so, the investigators use historical data to create returns to carry-trade, trend-following, and fundamental strategies for the major currencies, and they use regression analysis to investigate whether the returns of the various managers correlate with these benchmark returns. The majority of the funds (and the average index) appear to follow trend-following strategies; many also show positive carry exposure, but there is not much of a link with the return on fundamental strategies. Recent academic research has shown that the returns to simplistic trend following strategies are no longer statistically significant, but currency traders may follow more sophisticated strategies. The average excess return earned over 34 different managers with relatively long track records between 2001 and 2006 is 5.45%, and the average (annual) Sharpe ratio is 0.47, which is higher than the Sharpe ratio generated by the equity market. Pojarliev and Levich also check whether the managers outperform the benchmark returns. Deutsche Bank, among others, has introduced easily tradable funds that mimic the simple strategies represented by the benchmarks. For an investor, it would make little sense to pay the heavy fees hedge funds charge for exposure to an index that can be bought for a small fixed fee. Pojarliev and Levich find that only eight of the 34 managers significantly outperform a combination of benchmark indices that best describes their investment style.