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Handbook of Exchange Rates by Lucio Sarno, Ian Marsh, Jessica James

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17.6 Conclusions and Investment Implications

Over the last decade, institutional investors have been allocating less toward traditional assets such as equities and bonds, in favor of alternative investments such as hedge funds, private equities, and commodities. The increased interest toward alternative assets has naturally put currencies on the radar of institutional investors. Should institutional investors invest in currencies as an alternative asset class? The answer to this question is probably “yes” and the reasons are two-fold. First, the FX market offers enough depth and liquidity for large institutional investors. According to the latest Central Bank Survey of Foreign Exchange and Derivatives Market Activity (BIS, 2010), the daily average foreign exchange market turnover reached $4 trillion in April 2010, 20% higher than that in 2007. This liquidity was precious during the market turmoil in 2008. Second, returns generated by such strategies are generally uncorrelated with returns from other asset classes (Burnside et al., 2007). However, one of the challenges for institutional investors after allocating assets to currency managers is to find an appropriate benchmark to gauge the performance of these managers. Without an appropriate benchmark, the investor cannot know if he should be pleased or disappointed with the results achieved by his managers, or put differently, if these managers have demonstrated true skill or not. The lack of a well-established benchmark may be ...

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