To bet or not to bet?
What approach do you take to currency management?
CERN Pension Fund
• Invested assets: CHF3.9bn (€3.2bn), at Dec 2010
• Members: 6,678
• DB scheme
• Date established: 1956
• Funding level: 69% (open fund basis)
Since last year, our default position is to hedge 100% of our foreign currency exposure through a futures programme. A 100% hedge minimises volatility, which is a key objective of the capital preservation approach that our board adopted last year, and which is now enshrined in our statement of investment principles. As a result, our objectives are now expressed as a matrix that includes meeting the fund's actuarial return target, minimising the probability of loss of capital and maximising the return-to-risk ratio.
As a Swiss franc investor, fully hedging the currency risk has proved to be a good decision this year, even after the recent intervention of the Swiss National Bank. But we are operationally flexible enough to reduce the hedge ratio to as low as 70% under certain predefined conditions and, if justified, by an analysis of the risks and costs of hedging.
We use currencies as an additional way to express our major investment themes in externally managed mandates. In February we launched an offshore-renminbi fixed income fund. This fund invests in bonds, which are denominated in offshore-renmibi (CNH) and issued by major multi-nationals, such as Unilever. They are also sometimes referred to as dim-sum bonds.
Exposure to offshore renminbi, which is expected structurally to appreciate versus the US dollar, is a way to benefit from the emergence of China through the credit market rather than the equity market. I believe CERN was the first pension fund to launch a dedicated offshore-renminbi bond fund.
We do not have a currency-only alpha management programme because we see currencies as only one of many tools available to express macro themes. When it comes to such macro mandates, our approach is to externalise them to macro managers with best-in-class risk management and allow them to express their views through a variety of instruments, including currencies.
To separate the impact of hedging from active management, we spent the past year designing and implementing a customised account structure with our global master custodian, State Street.
Although at the fund level we tend not to take currency risk, our capital preservation approach requires that our managers actively manage assets. All active currency management mandates are outsourced. We have allocations to a number of external macro and systematic managers who have proven track records of extracting high risk-adjusted returns from currency strategies.
Pensioenfonds SNS REAAL
• Invested assets: €2.1bn
• Members: over 23,400, with 9,483 active
• CDC: Collective Defined Contribution
• Funding level: 117.8% (Aug 2011)
• Date established: 2004 as Pensioenfonds SNS REAAL
We formulate our hedging policy internally. However, it is executed by an external asset manager.
We hedge the foreign currency risk of our largest exposures with a derivatives overlay - in other words, we hedge if the exposure makes up more than 3% of the total assets in our portfolio.
The currencies we hedge are US dollar, Japanese yen and British pound, as we do not think risk and return are even on those.
We have been hedging the dollar and yen since the beginning but only added the pound hedge just over a year ago. We added it to our hedge because our exposure to the currency was growing.
When the pension scheme started in 1997 it was an insured pension agreement, meaning we had less control over and less impact on investment decisions.
When we changed from the insured format to our own risk carrier in 2004 we actively took the decision to hedge currency risk, although the US dollar and yen had already been hedged previously.
We have a currency hedge for approximately 75% - plus or minus 5% - of the portfolio, which we think is efficient and prudent. In our view, a full equity hedge would have too much transaction and too much volatility. If you have a 100% hedge, each time your portfolio changes due to tactical decisions made you would need to change your currency overlay as well.
We also believe in efficient markets. If you believe in efficient markets, you cannot beat the market and win an extra return on it, which is why we have never taken any active bets on currency. It is difficult to explain to scheme members why you took the bet. Active management is, of course, also more expensive than passive management.
And because we are not actively managing currency, we have fewer worries about volatility.
Our currency hedge was reviewed a couple of weeks ago and confirmed our current strategy as robust. We review it every two to three years.
Most pension funds in the Netherlands hedge their currency risk in a similar manner to us, with a higher or lower hedge ratio, depending on their risk appetite or the risk appetite of their sponsor without taking any active bets. Pension funds with rich, international sponsors, on the other hand, may not hedge their currency risk at all.
Universities Superannuation Scheme
• Invested assets: £30bn (€34.2bn)
• Members: 290,000
• DB scheme
• Date established: 1974
Non-UK assets make up around 60% of our scheme. Currency exposure is largely a by-product of diversifying our assets globally. Our strategy of hedging a part of this foreign currency exposure helps to reduce overall asset-liability risk for the scheme.
We started hedging our foreign currency exposure five years ago. We only apply passive hedging to our currency exposure in developed markets and undertake this using forward currency contracts.
The passive hedging process is carried out by the in-house team.
This hedging programme results in retaining the benefits of globally diversified portfolios of assets, whilst moderating the volatility from fluctuating exchange rates.
Apart from passive hedging, we may also express active views on foreign currencies. Currency exposure is reintroduced selectively, based on our expectation of how foreign currencies will perform relative to one another.
From the outset, we had flexibility to reduce hedges by some degree, though this was not much used. We have recently added a strategy team to our in-house management capacities, thereby increasing our foreign exchange (FX) expertise. We have recently instituted an active currency mandate, alongside but separate from the passive currency hedging mandate.
For us, active currency positions reflect a combination of different factors rather than distinct sub-strategies such as carry, momentum or value.
As our active mandate only went live this summer, it is too early to judge our experience with active currency management - although we clearly aim for it to benefit the portfolio in the long run. We believe that volatility in the markets - such as recently experienced - presents opportunities to us in active currency management.
Active currency management is also not uncommon among other large pension funds in the UK, although often via external managers. USS is unusual in the depth and breadth of its in-house investment resource.