Fundamentally an asset class is considered a separate class if in the long term it yields a risk premium. This means that in the long term, despite fluctuations in value, an increase in value occurs. Based on this definition, currencies are not an asset class. But it is possible over the longer term to generate yield with the help of passive income strategies. These are also uncorrelated to stocks and bonds or other asset classes, thus helping to make the portfolio less risky without any loss of yield. It is impossible that all currencies either simultaneously win against each other or that they all decrease in value.
For the passive strategy (without human intervention) three currency strategies are suitable:
- Valuation Strategy: The valuation strategy is based on the assumption of purchasing power parity. On the basis that a basket of goods should actually cost the same everywhere, undervalued currencies are bought and overvalued currencies are sold. It is assumed that in the long term the differences disappear.
- Carry strategy: Here it depends on the differences of the money market interest rates between different countries with different currencies. The strategy takes out loans in currencies with low interest rates and invests in currencies with high interest rates.
- Momentum strategy: This strategy follows the current trend of value of one currency versus another.
In the Asset Allocation Analyzer this asset class is represented with a real fund (ETF) that invests in all three strategies weighted equally. Before its introduction back testing is used.