The currency market has become an accessible, but risky, investment option, writes Caroline Madden.

Once the preserve of professional and institutional investors, the world's largest and most liquid market - the currency market - is gradually becoming a more mainstream investment option, albeit with its fair share of risk warnings and caveats in tow.

Speculating on currency movements, also known as foreign exchange (FX) trading, traditionally required very large financial outlays. However, a number of offerings now available on the Irish market have transformed currency trading into an accessible option for the small investor - albeit one with a healthy appetite for risk.

Investors with overseas assets, such as a British property or a shareholding in a US multinational, are usually aware that currency trading allows them to "hedge" their exposure to exchange rate losses. But in addition to their useful hedging properties, currencies are increasingly being viewed as an asset class in their own right.

One of the key advantages of playing the currency market is the power of diversification. Currency movements, such as the fluctuation of the dollar against the euro or sterling, are not correlated with the performance of other asset classes such as equities. So when stock market take a tumble, currencies tend to produce positive returns and vice versa.

However, unlike other asset classes, currency markets are in flux 24 hours a day and the inexperienced investor can easily fall foul of the sudden, sharp changes of direction often displayed by currencies.

For investors keen to leave the tricky decisions to the experts, a currency fund is probably the most suitable option. Friends First offers the only Irish currency fund available to retail investors, known as the Insight Currency Fund.

The fund managers Alder Capital - recent winners of the Investment Excellence in FX Hedge Funds (Europe) Award - have an impressive track record. Since the fund was established in 2001, it has produced a cumulative return of 63.6 per cent. This compares very favourably to a return of 37.4 per cent produced in the same period by Irish Life's Consensus fund.

So, what's Alder Capital's secret? Like most currency fund managers, it has developed a mathematical model that identifies the best time to buy and sell a particular currency. Alder's fund only invests in three currency pairs - euro/dollar, euro/yen, and dollar/yen - as these three pairs display the "directional movement" (ie they tend to move in one direction for a sustained period) which the Alder model is designed to take advantage of.

Brian McCarthy, director at Alder Capital, is quick to point that currencies should only form part of any individual's overall portfolio.

However, he says "sprinkling" currencies on top of a core portfolio of cash, bonds, property and equities can significantly improve its performance.

"Most assets that lower risk by their nature compromise on return, whereas currencies add to the overall return," he says. "Currency reduces the level of risk without hampering their ability to make money."

But how exactly does including a high-risk asset class such as currencies reduce the overall risk of a portfolio? This is where the power of diversification comes in. "Currencies don't have their good times and bad times at the same time as other assets and that's where you get the reduction in volatility," explains Mr McCarthy.

"The sum of the parts is better than either on their own. Currency fund management is something the banks and institutions have done for years because they're big enough to be able to play in this area," he points out, "but it rarely gets to filter down to the retail level."

Now that the option is there for the retail investor, are they biting? According to Friends First, the product is "gaining credence as an investment that would form a part of a well-diversified portfolio", although it conceded that it was a "niche investment".

For individuals who prefer to be actively involved in managing their own investments, spread betting is becoming an increasingly popular method of tapping into currency markets. With spread-betting, an investor stakes an amount on the movement of a currency in a particular direction, rather than actually buying the underlying currency itself. The profit or loss generated from the trade depends on the extent of the price movement multiplied by the stake.

According to Michael O'Shea, joint managing director of Delta Index, currencies are now one of the most popular asset classes with their clients.

"A lot of our clients would come on initially to do equities which they're more familiar with but they tend to find their way to currencies," Mr O'Shea explains. "We recommend that people start off with equities and only when they're comfortable to move into currencies, which can be quite volatile."

As speculators can place trades for as little as €1, spread betting makes currency trading far more accessible to investors than traditional routes.

"To go to the kind of bigger brokers that we might use for hedging purposes you're likely to need an account of some size, whereas with Delta Index it's a way that you can begin to take exposures to things like currencies with relatively small amounts," he explains.

However, because spread betting provides the ability to leverage or gear up, it can prove to be a double-edged sword. Large profits can be reaped from very small movements in the trader's favour, but similarly large losses can quickly mount up.

"We recommend clients take their time in understanding the market that they're trading in before they invest too heavily in it because currencies can move quite quickly," Mr O'Shea adds.