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Currency Overlay in Reserve Management
For Institutional Investors Only — Not for Onward Distribution
On average, we find that the tilted portfolio would have been 67.9% exposed to USD, slightly above
the benchmark average of 64.1%. The lowest exposure to USD was 52.2% in January 2003 when
trend and carry signals recommended switching out of USD at a time when value didn’t have a strong
input. The largest exposure to USD was 89.2% in November 2005 when positive USD carry, strong
spot momentum and cheap valuations aligned.
When applied to a hypothetical reserve portfolio worth USD 10bn, the median monthly trade size for
EURUSD, the biggest overlay exposure works out at around 390m USD equivalent — a manageable
size once intelligent execution methods are considered. Median trades for USDJPY and GBPUSD
work out at 63m and 44m USD respectively and far less for other currencies.
Figure 2 and Figure 3 show that the overlay has added 0.38% to the annual return of the reserve
portfolio while reducing risk (volatility) by 0.12% per year (Jan-02 — Jun-15). As a result, the Sharpe
ratio over the US risk-free was improved from 0.70 to 0.79.
On the other hand, the overlay increased the maximum drawdown during the Q3 2003 bond market
sell-off by 0.66%, because the signals originally advocated a long EURUSD overlay due to strong
upside spot momentum in Q2 and positive EUR carry. However, during other times of bond market
weakness the overlay added value, for example increasing the return between Jun-14 and Jun-15
from -3.8% to -2.76%.
The CitiFX Quantitative Investor Solutions team has been developing investable currency solutions
for institutional investors since 2006. Our team of dedicated quantitative analysts can help our
clients understand, manage and generate value from exposure to currencies. Citi is one of the
world’s largest foreign exchange banks, trading over 140 currencies out of 83 centers. If you would
like to hear more about what we can do for you, please contact your Citi salesperson or the Public
Sector Group.