Most re-brands come across as pretty superficial affairs. At best they represent a transition from clunky to funky. But when Lee Overlay Partners changed its name to Adrian Lee & Partners in July 2011, it reflected a profound change in the perception of currency management by institutional investors and consultants – especially in the key UK market.

“We wanted to remove ‘Overlay’ because the market increasingly associated it with passive risk management – and we don’t make that big distinction between overlay and active management,” says founder, president and CIO Adrian Lee. “While we do provide a passive hedge for clients who use our active strategies, we would never provide a pure, standalone passive hedge programme – it’s an important service, but we let other managers and custodians provide it.”

This is not to say that the firm no longer believes in currency overlay – quite the opposite.

“I was one of the originators of currency overlay for institutions at JP Morgan and I founded Lee Overlay Partners because I felt, and continue to feel, that there is a huge need for it among institutional investors,” Lee says.

But he also believes that overlays can – and maybe should – be active. That puts Adrian Lee & Partners at the heart of the difference of opinion between most UK consultants, who tend to see active currency as risk-additive, with no place in a risk-reducing hedging programme, and most active currency managers, who maintain that their skills are indeed risk-reducing when applied to a hedge-ratio benchmark.

Does this go some way to explain why AUM has fallen from its peak of close to $9bn in 2011 to today’s total of just over $6bn? After all, performance continues to deliver steady excess returns.

“Performance has been good, business has been OK,” Lee concedes. “Already a couple of years ago I questioned why we hadn’t really taken off, when some competitors had gone to $40-50bn. I came to the conclusion that it was mainly because we didn’t have a London office.”

Opening up an office in London four years ago cannot have hurt, but if anything the assets have stalled since then. Perhaps there is a deeper problem.

“None of our US clients have pulled money, Australian clients still feel they need it – we’ve seen no diminution of demand from outside the UK,” says Lee. A weighty, AUD2.3bn (€1.6bn) mandate from the Vision Super scheme in September 2013 is evidence of that – indeed the firm has grown 25% since this time in 2012.

It’s very obvious why Australian investors tend to be engaged – most of their portfolios are ex-AUD and they have lived through a long period of AUD strength. Japanese and US investors face a similar, if slightly weaker, case. That case is much weaker for euro-based investors since the advent of the single currency. But how to explain UK investors’ lack of appetite? They have enjoyed a period of GBP weakness recently – but their increasingly international holdings make them vulnerable to a change in that regime. Again, it’s active hedging they have rejected, rather then hedging per se.

One well-known problem with the initial wave of active currency management in the UK was the focus on the carry strategy, which was perfectly suited to the pre-crisis environment but got hit badly by the return of volatility in 2008.

Adrian Lee & Partners isn’t a carry-trade sceptic – carry powers its ‘International Risk Premium’ strategy – but it differs from some of the managers that got caught out in two ways: by being diversified (its core currency programme trades across 32 pairs); and by including a discretionary element in its overall strategy.

The first of its three ‘alpha centres’ focuses on about 10 fundamental factors (including but not exclusively interest rate differentials) that the firm’s research suggests are robust; the second focuses on technical indicators such as momentum. The models in this systematic part of the strategy are adhered to absolutely, with no overrides. However, a proportion of the portfolio is determined by the third alpha centre – discretionary forecasting of the fundamental factors that drive the first alpha centre. This can act as a powerful diversifier when the inevitable tail risks ambush the quantitative programmes.

“In the UK a few managers were particularly hard hit [during the crisis],” says Lee. “That led some consultants, who might have oversold the idea in the first place, to decide that they are not going to push the idea of active currency management with UK pension funds.”

Adrian Lee can deal with the impasse by continuing the steady returns, of course, and by making the active-management case – which may become easier as global rates normalise. But it can also broaden its product range, as it did earlier this year with the launch of its local currency emerging market fixed income strategy.

This was a natural move for the firm. Leaving aside the recent popularity of the asset class, and the much-improved fundamentals of most emerging economies, Lee notes that 70-80% of emerging-market bond risk comes from the currencies.

“Those currencies are not necessarily unattractive, but it’s just not always well-understood that emerging market bonds are, first and foremost, a currencies game,” he says.

But that still leaves 20-30% coming from the bonds, which is why, when a client suggested the idea, the firm first spent two years searching for the same sort of robust fundamental indicators for a quantitative process in bonds that are at the heart of its currency programme.

“We identified the key drivers of bond-market risk and used those to create four fundamental signals and one technical signal,” Lee explains. “Only when we succeeded in this research did we push on with the product.”

The firm’s existing emerging-currencies process combines with this new bond-market process, each contributing half of the risk towards a 3-4% tracking error.

Treating the bond and currency decisions separately is crucially important but often neglected, Lee says. Correlation between an emerging country’s bonds and FX is typically about 0.20 – similar to that between its equity and bond markets. After all, the fundamentals driving currencies are differences in the price and quality of traded goods, the current account and capital flows, whereas debt markets are driven by monetary policy, inflation and growth.

“No-one says, ‘I have a positive view on UK equities, so I think I’ll also buy a chunk of UK Gilts, too’,” Lee points out. “At best the average emerging market bond manager buys a bond and looks at the currency as an afterthought. At worst investors commit some pretty sloppy thinking, assuming that if they are buying ‘Brazil’ then they must have a positive view on the real. No other emerging market debt manager can put up their hand and say that they are a currency manager, and I believe we are the only product out there that genuinely separates it out as an equally-important part of the active strategy.”

The firm’s research suggests that this unbundling alone can contribute up to 15% excess annual return versus an aggregate decision based on one process. That’s a big cushion against getting some of the bets wrong.

Now Adrian Lee & Partners just have to hope that the summer’s sell-off in emerging market bonds doesn’t dent institutional investors’ enthusiasm and put it on the wrong end of yet another change in investment fashions. If it doesn’t, and if the case for active currency management starts to get a fairer hearing again, maybe the its AUM can continue to grow again from here.