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Regional Chief Investment Officer Brian Singer says unwinding of the carry trade is imminent
The "carry trade", a currency trading strategy that for several years has proven very successful for investors, appears close to a turning point that would end its effectiveness, according to Brian Singer, Regional Chief Investment Officer for the Americas and Head of the Global Investment Solutions (GIS) team for UBS Global Asset Management.
"We have positioned our portfolios to profit from when the currency carry trade inevitably unwinds," said Singer. "Given our views, we could be seen as wandering dangerously away from the flock. However, we see clear evidence that the herd mentality is destroying the mechanism through which currency prices - or exchange rates - reflect their true value."
The carry trade is a currency strategy that looks to profit by selling low-yielding currencies, such as the Japanese yen (JPY), and buying high-yielding ones, such as the Australian dollar (AUD). Apart from a transfer of cash, this currency transaction requires the investor to pay the interest rate of the currency sold, and receive the interest rate of the currency bought, with the difference between them known as the "carry". Should the carry be greater than the move in the exchange rate between the two currencies, the investor will profit.
In the report, Singer notes that as volatility has rebounded from multi-year lows over the past three months, the supportive environment for carry trade performance has been diluted. With volatility's rise, UBS Global Asset Management's analysis indicates that the overvaluation of positive carry currencies, which have been driven further upward by the public's high carry trade appetite, has a high likelihood of correcting in the not-too-distant future.
"In the end, UBS Global Asset Management manages currencies as it manages any other asset class, believing that the fair value of a currency is best represented by economic fundamentals," added Singer. "As such, we look for over- and undervalued currencies relative to fundamental fair value and do not rely solely on cyclical trends like the carry trade."
The views of Brian Singer and the GIS team are contained in the latest issue of Current Perspectives, a quarterly publication of UBS Global Asset Management. The document may be found at www.ubs.com/globalam-us.
The views expressed in Current Perspectives are as of April 30, 2007, and are those of UBS Global Asset Management. These views are subject to change at any time in response to changing circumstances in the markets, and are not intended to predict or guarantee the future performance of any individual security, asset class, the markets generally, nor are they intended to predict the future performance of any UBS Global Asset Management account, portfolio or fund. The information contained herein does not constitute a distribution, an offer to sell, or the solicitation of an offer to buy securities or funds.
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New York, June 18, 2007