Investors Should Abandon the Yen-Funded Carry Trade, UBS Says

Investors Should Abandon the Yen-Funded Carry Trade, UBS Says

By Bo Nielsen

Jan. 30 (Bloomberg) -- UBS AG, the world's second-largest currency trading firm, says investors should stop selling yen to buy higher-yielding assets overseas because rising volatility and financial-market turmoil favor other strategies.

Carry trades will be unreliable this year as banks cut financing in the wake of credit market losses and changes to Japanese investment laws reduced sales of mutual-funds built on foreign securities, Ashley Davies, a UBS analyst based in Singapore, wrote today in a note to clients.

``The carry trade will not return in a big way and will not be a reliable generator of returns in 2008,'' Ashley said. ``Investors are better off trading other macro themes such as slowing global growth, downside risks to specific economies and the increased likelihood of policy error by central bankers.''

The yen has been the best-performing major currency this year, gaining 4 percent against the dollar and 2.7 percent versus the euro. The Japanese currency traded at 107.26 against the dollar by 11:41 a.m. in New York, from 107.11 yesterday. It was at 158.52 per euro from 158.27.

In carry trades, speculators get funds in a country with low borrowing costs, such as Japan, and invest in one with higher returns. They earn the spread between the two. The risk is that currency fluctuations may erase profits.

Japan's benchmark rate of 0.5 percent is the lowest among major economies. It compares with 8.25 percent in New Zealand and 4 percent in the euro region.

Implied Volatility

The value of futures contracts held by traders on the Tokyo Financial Exchange betting on a drop in the yen, compared with those betting on a gain, has fallen by more than half to $2.2 billion since August, Davies wrote. Investment trust outflows from Japan slowed to about $1 billion per month in November and December from an average $6.5 billion prior to July, he wrote.

The implied volatility of a one-month dollar yen option rose to 13.2 percent today from 13 percent yesterday. The two- year average is 8.8 percent.

UBS had about a 15 percent share in the foreign exchange market, trailing only Deutsche Bank AG's 19 percent, according to a survey last year by Euromoney magazine.