With trillions in currencies exchanging hands every day, foreign exchange is
indisputably the world’s largest and most liquid financial market.
Yet in spite of its size, this report argues that it is also likely to be
the least “efficient” compared to other asset classes.
We review the latest data from a wide range of sources and conclude that only
45%-60% of forex (FX) market participants are likely to be profit-seeking. The
presence of a large portion of non-profit maximizing participants explains why
the efficient market hypothesis fails to hold in currencies and why FX moves
can be both predictable and profitable. The rising share of passive investors as
well as the increasing importance of regulation suggests that the FX market
may be becoming less, rather than more efficient over time.
We review the returns provided by investing in the currency markets since the
1980s and find no evidence of deterioration over time. A simple rules-based
approach using the Deutsche Bank Currency Returns index (dbCR) involving
carry, valuation and momentum strategies has provided stable risk-adjusted
returns that have been resilient even after the shocks of the 2008 financial
We also find consistent evidence of positive FX manager returns and introduce
a number of new trading strategies.
We compare FX market returns to bonds and equities and show that currencies
have offered comparable risk-adjusted returns compared to a global fixed
income or equity portfolio since the 1980s.
We show that the addition of FX to a bond and equity portfolio has material
diversification benefits by reducing volatility and the drawdown of returns.
We explore the drivers of FX hedging and evaluate the merits of dynamic
We argue that hedging always involves an opportunity cost and even profit-
constrained or transactional participants need to carefully consider their
approach to FX.
We conclude that currencies as an asset class are “alive and kicking” and that
the FX market is likely to continue to offer excess returns to investors for the