Again, it is probable that most currency overlay managers might not appreciate being labelled as speculators. Here however, the definition we have used in this blog for currency speculation appears to work well. After all, the very job of a currency overlay manager is to differentiate currency risk from underlying asset risk within the overall risk profile. Active currency overlay requires that currency risk be managed separately and independently from the underlying. Therefore de facto, it falls within our definition of currency speculation. This does not mean that a currency overlay manager is of necessity anything like a prop dealer or a hedge fund. The job of a currency overlay manager may be either to ensure the total return of the portfolio by reducing risk as much as possible, or alternatively it may be to add alpha.
Either way, currency overlay managers use currency hedging benchmarks. They can manage the currency risk passively by maintaining the currency risk according to the benchmark. Alternatively, they can manage the currency risk actively by trading around the currency benchmark to add to the total return of the portfolio. The former are clearly not currency speculators in that they are hedging currency risk related to an underlying asset and moreover they are doing so passively. They are not “taking a view”. The latter group, who trade actively around the currency benchmark, are indeed currency speculators in that they are taking positions not specifically related to the underlying asset.
Corporate Treasurers and currency overlay managers may think their world is as far away as one can get from those of the prop dealer or hedge funds, but there are times when the distinction between the two sides becomes decidedly less clear than many might like to think. In turn, this should mean one takes a more balanced and measured view of the very topic of currency speculation.
The second group of currency speculators is that of the “proprietary dealer”. This individual is usually among the most experienced currency dealers in the dealing room. He or she plays no part in providing liquidity for client orders, but instead uses a designated amount of the bank’s balance sheet for the specific purpose of position taking in the currency markets. A “prop” dealer may take these positions based on any combination of fundamental, technical, ?ow or quantitative considerations. He or she has the luxury of not having to quote or make markets for others. On the other hand, their value to a bank comes in the form of one number alone, their P&L at the end of the year. They get all the kudos and all the blame depending on what that number is. They are a bit like racing drivers — and many would be happy with that analogy. There are old prop dealers and bold prop dealers, but no old, bold prop dealers! The analogy is meant in light-hearted fashion. Good prop dealers are extremely hard to find. Most that I have met are in complete contrast to the image of a financial market dealer as loud and brash. On the contrary, many are relatively quiet, analytical and extremely bright.