THE BLOG

Put Currencies in Your Portfolio

22/04/2014 13:23 BST | Updated 22/06/2014 10:59 BST

Why shouldn't your portfolio have exposure to the largest and most important market in the World? The Foreign Exchange markets trades over $5 Trillion per day, and is super liquid and offers the volatility for solid, consistent profits.

The reason why most portfolios don't have exposure to higher risk assets is that most portfolio managers don't have the training or experience to trade higher risk-reward asset classes like futures and currencies. Investing has different rules than trading. Investing is heavily biased by the Prudent Investor dictum that can leave portfolio managers liable for poor investment decisions. As most portfolio managers practice the industry standard fundamental and technical analysis, "riskier" investments are usually avoided.

The investment management industry is based more on long-term capital growth and preservation at reduced risk. A valiant goal in itself. However, trading skills are not the same as those required for making intermediate and long-term strategic investments decisions. A properly trained and proven currency trader can produce a comparatively high return with limited risk. This limited risk is due to the short position exposures-one day to several days at most.

Trading is down and dirty and requires total focus on real-time price movement. Trading currencies requires not so much an understanding of macro-micro economic factors rather a solid understanding of human behavior during market swings and being able to see and anticipate those swings. Trading is all about leveraging fear and greed...and that is a lot easier to spot and understand than trying to forecast the chaos and complexity of markets.

In 1990, Harry Markowitz won the Nobel Prize for his Modern Portfolio Theory. This theory states that the main contribution to profits over the long-run is the proper allocation and balancing of a spectrum of different asset classes with differing correlations. Indeed, MPT suggests that every portfolio should have a portion dedicated to higher risk-reward vehicles-preferably negatively correlated to the majority of assets in the portfolio. If you do a search, most of the investment industry doesn't consider currencies as an asset class. This is mainly because of the complexity of elements that affect currencies. Interest rates, social and political stability and nation status as exporter or importer may or may not at times be correlated to other assets. Indeed, the S&P is at a peak and the USD is down near its lowest value in years. Sometimes there is correlation and sometimes not. However, this is because currencies are not for long-term investments. They need to be traded on the short-term spot market.

To add some credibility to this post, Deutsche Bank, one of the world's major currency market makers, suggests to its clients that they should diversify their portfolio with foreign exchange investments. In the words of a Deutsche Bank promotional piece, "The foreign exchange markets offer investors the opportunity to diversify their portfolios from stock and bonds. Investors who diversify their portfolios, by including foreign exchange as an asset class, can lower the overall volatility of their portfolio."

But here is the rub. Most portfolio managers don't want to lose control of portfolio assets and they are not familiar with trading currency. So, what is an investor to do? If your portfolio manager doesn't include some currency in your portfolio asset mix, take 10% of your portfolio and place it with an experienced Forex currency trader. You will most likely be pleasantly surprised.