It was so easy to make money from carry trades even retail punters were heavily in on the act û during the past few years Japanese households have sent trillions of yen to New Zealand and Australia, but as the easy money dries up, private investors are exiting in their droves and handing the foreign exchange market back to the professionals.
That could be a mistake because forex has great potential as an asset class. For starters, the market is huge and extremely liquid û $3 trillion of currency trades change hands every day, which makes the forex market about seven times bigger than US equity and treasury markets combined. There is also very little correlation with other asset classes, making it a great diversification play.
Even so, while many investors are comfortable making bets on the share prices of household names like HSBC or Toyota, very few are confident about the direction of euro-yen, for example.
Have no fear; a new product from RBS promises to give investors an opportunity to become currency traders without having to worry about the myriad indicators that can influence currency movements. The FX Select Trading Note is a five-year capital-guaranteed product that uses an automated currency trading model to make bets on currency pairs.
The model monitors six currencies from around the world against the US dollar û euro, Brazilian real, Korean won, Canadian dollar, South African rand and the Taiwan dollar û and each month picks the two currencies with the strongest trading signal, which is calculated by comparing the current market price of each currency to its average price for the past 40 days.
"If the spot rate is above the moving average, that's a buy signal. If it's below, that's a sell signal," says Chris Leuschke, RBS' global head of currency structuring. "The model will either go long or short on the two strongest-signalled pairs."
The strategy could be used on any combination of currency pairs, but the RBS team has chosen what it thinks is the optimum basket to provide stable returns and low transaction costs. "We tried to select currency pairs that represent the globe but we didn't want pairs that were illiquid," says Leuschke. "Then we looked at all the currency pairs to pick ones with 40-day moving averages that worked well."
This is why the yen-dollar pair isn't included û it just happens to work better with different moving averages.
RBS is recommending the five-year product with 200% participation û because this gives the most reliable return û but other options are available. The life of the note can range from three to five years, with 200% or 400% gearing.
The recommended five-year product is 100% capital-guaranteed, with earliest redemption after four years û if the gross position falls to 88.5% of its initial value the investments are closed out and the investor gets his money back at year four. In the fifth year, this low-performance barrier reduces by 0.5% each quarter.
According to RBS's back-testing, using historic data going back 10 years, the 200%-participation note would have paid investors an average yearly return of 15.2% when it survived to maturity û for the five-year note, 13% of back tests hit the performance barrier and redeemed early, compared to 20% for the four-year and 29% for the three-year. When the leverage is increased to 400% participation the average return rises to 30.4%, with early redemption rates of 30% on the five-year, 36% on the four-year and 43% on the three-year.