Transparency misleading when trading at the fix.

Investors need to reconsider the point-in-time (PIT) strategy when trading foreign exchange as transaction costs can outweigh the apparent transparency, according to a paper produced by global asset manager, Russell Investments.

The paper, Does Trading at the Fix fix FX?, explores the viability of using a fixing price for FX transactions, and whether it provides the best outcomes for investors after considering factors within the trading process. PIT execution involves buying and selling foreign currencies at a particular time or times, generally the same time daily, with the most common benchmark being the WM/ Reuters London 4pm fix, also referred to as the London close.

According to Russell Investments Head of Foreign Exchange, Michael DuCharme, the popularity of PIT execution strategies is spurred by investors’ desire to trade at a transparent price.

“As the FX market is an opaque and largely unregulated environment, investors lack market trade information and the ability to verify times at which trades are done. Many consider trading at the fix as a way around this as there is an exact daily price, making it easier to value international portfolios and compare them to other international portfolios and benchmarks,” he said.

Mr DuCharme believes many investors are using these benchmarks without considering the broader risks and implications on the trading process. “We have found investors focus on minimising tracking error to the point where some of the fundamentals of trading, such as volatility, liquidity and bid-offer spreads, can be overlooked.”

Some key issues with employing a PIT trading strategy include:

• Best execution – because exchange rates are random, it is unlikely that the best price of the day will consistently be observed at a particular time such as the London close
• Position adjustment and manipulation – dealers can offer better – or worse – prices in an attempt to reduce their risk heading into the close. More recent press has described how dealers allegedly manipulate the market through ‘banging the close’, the practice where dealers execute a large number of trades close to fixing time to influence the rate
• Declining liquidity – popular trading times represent times when currency markets are transitioning from one global region to another, which is often marked by declining liquidity and increased volatility.

Russell advocates the use of alternative benchmarks in FX trading such as a volume-weighted average price (VWAP) which is determined by the actual trades an investor executes and then comparing that outcome to the average rate for the traded currencies during a day or over a transaction period.

Russell’s Head of Implementation Services in Australia and New Zealand, Daniel Birch, said the paper identified significantly higher volatility for an investor’s selection of trading at a point-in-time compared to a volume weighted approach.

“As most investment managers trade currencies to fund international security transactions rather than to profit from volatility swings, tolerating the excessive risk is unnecessarily costly,” he said.

Russell’s Managed FX Trading program employs the agency model which is designed help investors capture more of the return benefits of an international portfolio allocation, with processes in place to provide greater transparency and operational efficiency to their funds.

Russell’s Agency FX services utilise the firm’s expertise in portfolio implementation, and by integrating it into a broader investment program, clients can achieve diversification within a multi-asset portfolio.

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