“In 2012, Harmonic captured trades that few others were looking for” says investment partner Patrik Säfvenblad. The manager followed the same core methodology and trading style as they always have done since the firm was founded in 2002, by Richard Conyers and David Pendlebury. Whereas the relative stability of G3 currencies limited opportunities for most currency traders, the wide dispersion of returns among smaller and emerging currencies was helpful for Harmonic, which trades a broad range of currencies, including 45 emerging markets pairs since 2009, on top of the G10 units. Market moves such as the Australian dollar versus the New Zealand dollar, the Brazilian real against the Chilean peso, the Turkish lira vis à vis the Israeli shekel, or the Hungarian forint compared with other Eastern European currencies, can make substantial contributions to Harmonic’s returns.
These peripheral and often less widely followed currencies can be important because Harmonic weights each currency pair equally on a risk-adjusted basis. Taking the Brazilian and Chilean currencies as an example, the close relationship between the two allows Harmonic to maintain relatively large positions. In practice, these emerging market currency positions are traded against the US dollar which are liquid and have low transaction costs.
There is no structural bias to be long or short of the carry trade, although some of Harmonic’s models and trades are explicitly trying to time carry, partly through estimating risk appetite. The fund was heavily short of carry in 2008 for example, when the Harmonic Macro Fund produced returns in excess of 15%. Measured through time Harmonic is more often long than short, but that is only because up moves in the carry trade last longer than down moves. The correlation to currency carry indices has been only a slightly positive 0.3 since inception in May 2003, and correlations to macro and trend-following strategies are also low.
Plenty of non-carry models estimating what will drive markets in future have been built by the investment and research team of nine in both developed and emerging market currencies. While this is mainly a quant macro fund, with fundamental inputs making up 80% of trading signals, technical factors such as momentum form the remaining 20%. The Harmonic Currency Fund is a pure subset of the currency allocation within Harmonic’s Macro Fund, which also trades equity indices, bonds and commodities via futures. It is natural that a macro manager would draw inferences from other asset classes to help inform trading decisions in the currency markets.
Fixed income markets can give important clues in projecting which countries are expected to raise interest rates in future, which can then be translated into currency views. Another example of lateral thinking is evident in using the behaviour of equity market investors to estimate currency market views. Harmonic take the view that equity and bond investors are also currency investors.
Holding periods range from a few weeks to a few months, with an overall average of around six weeks. As it is very cheap and easy to trade currencies, core positions can be resized and rescaled on a daily basis in response to marginal signals.
Risk management follows common sense logic, in reducing the size of losing positions in a particular market or model. Yet the overall fund risk target does not change from day to day. Harmonic has been adept at forecasting its volatility: the average annual figure of 13% sits inside the 16% target.
The collapse in correlations between currencies bodes well for the currency fund’s style of trading. The emerging market currencies have provided strong diversification benefits against the G10 currency models in the fund. Altogether there are now six families of models in the fund, which has generated positive returns during both risk-on and risk-off markets. The strategy can be accessed through a fund, managed account platforms, or dedicated managed accounts. Harmonic’s $900 million of assets leaves plenty of capacity available to trade these liquid markets.