Improving investment performance in 2023

by Richard Class

Improving investment performance

Challenging backdrop

The macro environment for generating returns in 2023 is challenging. Material headwinds include the ongoing tightening of monetary policy, the war in Ukraine, a lack of political leadership, climate change, and China’s handling of Covid. The difficult market conditions are compounded by more regulatory scrutiny and the demands from both investors and regulators for an increasing focus on sustainable investing.

Minimising the costs of investing

Whatever your underlying asset class, a robust philosophy and process are necessary but not sufficient conditions for success. Whilst your principal focus should be on generating returns, paying close attention to minimising the costs of investing is also a way to improve your performance. As Sir Winston Churchill said:

To improve is to change, so to be perfect, is to change often

Sir Winston Churchill

The costs of hedging risk and financing positions are often implicit or are opportunity costs rather than an explicit drag on returns and hence they may not be so obvious.

Evapourating liquidity

A recent report by the Bank of International Settlements highlighted that there are USD85 trillion in mainly short-term outstanding liabilities in US dollars arising from FX swaps, forwards, and currency swaps, largely held outside the US. In times of market stress such as 2008/9 and in March 2020, the cost of refinancing these USD liabilities rose sharply as liquidity evaporated (the negative “basis” effect).

This risk directly affects all non-USD based investors who implicitly fund their USD assets via FX swaps, and indirectly affects USD based investors too. What exposure does your organisation have to this risk? If markets become stressed, what would the impact be on your investment performance? How do you/could you ameliorate it?

Many investors had lower returns in 2022, driven by mismatches between LIBOR and SOFR (the overnight rate) in funding markets, and the bifurcation for 1-month and 3-month reference rates used for assets and liabilities. How did these distortions affect your performance?

Holistic, practical and tailored approach

OptimX’s mission to partner with our clients to enable them to generate better performance without a material investment in time and resources. We take a holistic, practical and tailored approach, by considering all the areas where savings could be achieved. These include the following: hedging (for all asset classes), funding/financing of positions, custodian relationships, prime brokerage, and stock loan arrangements. We provide the expertise and granularity required to identify where improvements can be made and then to execute on them, using a combination of both technology and our own extensive experience.

OptimX begins its relationship with a client by seeking to understand what your approach to hedging and execution is. This will help us ensure that you have the best strategy in place. In dynamic and increasingly volatile rates and FX markets, we recognise that there can be trade-offs between excellence of execution and operational efficiency, and we aim to strike the right balance. For example, electronic trading does not, of itself, guarantee best execution. Placing FX orders on to a platform could push the market away from you, or result in you crossing large bid-offer spread, particularly in less liquid currency pairs. It may be more effective to consider alternative strategies.

Optimise execution

Having analysed whether a client is adopting a strategy that best meets their objectives, the next step is to optimise execution. Our discreet and confidential approach enables us to ask specific questions such as “Do you know how much your counterparties are charging you in each area?  Are you sure?”  We focus on enabling you to obtain sharper pricing across all products and on streamlining execution to create the most efficient manner to execute in each market and to optimise the frequency and timing of execution.

In conclusion, OptimX can help you to lower costs and boost profitability, whilst you retain control. We live in uncertain times, so reducing the costs of investing could be an important contributor to your bottom line in 2023.