City of Edinburgh Lothian Pension Fund
When the £2.4bn City of Edinburgh Lothian Pension Fund decided to appoint three managers to run an active currency overlay programme earlier this year, it was the scheme's first involvement with currency. The fund opted to enter the currency space because it had moved away from UK equity exposure and built specialist international briefs. It hired AG Bisset, Record Currency Management and JP Morgan to manage the contract, but declines to provide further details on how the brief is divided between them. The managers must implement a 50% passive hedge, and actively target a 2% return from the nominal foreign currency exposure of the fund.
The brief only encompasses overseas equities for the main Lothian Pension Fund (the scheme also invests and administers separate funds for Lothian Buses and Scottish Homes), and a spokesman says its selection was based on normal EU competitive tendering processes. Pertinent factors were scored against agreed criteria such as business strength and growth, quality of process and people, performance, fees, and risk control.
California Public Employees Retirement System (CalPERS)
The $200bn (€156bn) California Public Employees Retirement System may have had a currency programme for the past 14 years, but investing in currencies just got more interesting, says Eric Busay, portfolio manager. "We originally started out with a defensive programme, and the main goal was to reduce risk. But even from inception, we needed to have some active components in the mix. From the beginning, we had an asymmetrical 100% hedged benchmark. Managers were able to lift hedges, and effectively go long currency when appropriate."
Five years ago the fund started an internal passive programme to both build credibility in the marketplace, and develop the ability to execute trades. Now, CalPERS is taking it one step further. Busay has just convinced the investment committee to approve an in-house active hedging programme which is also asymmetrical and would allow the manager to have latitude of anywhere from a 0-200% hedge. "We are starting with $100m, which is a small percentage of assets compared to our entire currency programme, which is approximately $11bn."
The fund has been developing strategies internally for some time, and has subscribed to AlphaEngine, the portfolio decision-making tool from Mcube Investment Technologies, to help make currency calls. "In many cases the system simplifies the process of model building, and uses relatively simple approaches that don't require a great deal of programming. It's also easier for a person who has not created the model to be able to audit them and understand them," says Busay.
The fund is working alongside Mcube and is testing the model, restricting it to just currency. Overall, $3bn of the $11bn in currency is managed in-house, and Busay hopes that if the testing is successful, the fund will relax its guidelines for external managers. "But we have every intention of continuing to use external managers. It provides a diversification of manager styles," he says.
He says he is taking a conservative approach. "The objective is to gain value. When you are talking about $11bn, even a small incremental gain can add millions of dollars. We don't want to be too aggressive, and we don't want to be perceived as taking large currency bets. We want to consider this as a compliment to our entire portfolio," he says, arguing that pension funds often view currency as an after thought. "We prefer to suggest that because currency is such a great diversifier of the portfolio, it should be considered at the entire portfolio level."
San Bernardino County Employees' Retirement Association
The $4bn-plus San Bernardino County Employees' Retirement Association scheme is also using Mcube's AlphaEngine for currency management. "We went live with that on 6 July, and the rules we use are relatively straightforward. We use curve and carry. The platform is effectively designed to compare trades," explains investment officer Donald Pierce.
Unlike many pension funds, San Bernardino has an unhedged benchmark. "It has always been unhedged. Most of our currency exposure is in the dollar. When you see a home country do a lot of hedging back to their own currency, what they are really saying is that the country they are investing in doesn't have as large a market, so consequently hedging back their foreign currency exposures might be a useful thing," he says.
San Bernardino has only about 30% of its allocation to international assets. "It's strategically low, but for our peer set is good," says Pierce. The fund uses overlay strategies and managers could go long or short the dollar, but Pierce, who heads a team of three, says it would be very difficult to do much in-house. "Its 107 degrees outside today, and we are in the middle of the desert. It's hard to attract managers here," he jokes. Still, the fund talks to "less than half a dozen" currency managers, largely, says Pierce, because it is about building relationships and being comfortable with them.
Universities Superannuation Scheme
Richard Fisher, bond manager at the UK's £22bn Universities Superannuation Scheme (USS), approaches currency differently "People fall into two distinct camps. One is traditionally equity-led, where currency management tends to take the currency risk as part of a diversification play. From a bond perspective, we have a completely opposite view to that. Currency risk is not desirable on the bond portfolio side. It has undesirable characteristics with very little expectation for return," he says.
The fund's global bond portfolio is fully currency hedged, and where it is exposed in foreign markets, currencies are hedged back to sterling. "If we have a positive expected return from a foreign currency we would lift some of that hedge and get some exposure," explains Fisher.
The fund's investment process is reviewed on a monthly basis, and Fisher recommended a fully hedged benchmark to the committee in June of this year. "Hedging does need some explaining. At the end of the day, the investment committee are there to test ideas we put forward, even if we think it's an easy sell.
First we looked at the historic data, which gave a clear indication that the nature of bond portfolios changed if we reduced currency risk, and we also discussed the dilution between bonds and equity diversification." Fisher also points out that the expected return of a bond portfolio hedged back into sterling is greater, because foreign interest rates are on aggregate lower risks.
Still, USS does not have currency specialists for alpha generation. "I understand that is something that will be reviewed as a potential asset class and will be considered under alternative assets," says Fisher.
PME, the industry-wide pension fund for the Dutch engineering sector, does not have a dedicated currency team. Bert Leffers, fund manager, makes tactical decisions about currency. The fund thinks of currency on both strategic and tactical terms. 100% of US dollar, yen and sterling exposures are hedged via currency forwards. Internally, for instance the fund has gone long a basket of 14 emerging markets currencies, while shorting US dollars, yen and euro. In total, it has an exposure of€900m, or €65m per currency.
PME uses three external managers, which can take positions in currencies, and a further six indirectly via, for instance, global equity briefs. The fund says it is difficult to separate out alpha from its strategies, but that over time, pure currency bets make a small but consistent gain.
Gerlof de Vrij, head of global tactical asset allocation at ABP, says the fund hedges its dollar exposure 100%, because it reduces the volatility of its assets. "It provides a better match with liabilities, and the risk we take on currencies is not rewarded."
The fund normally assumes an alpha of an information ratio of 0.7 as doable. "I think there are several risk premia in the currency markets," says de Vrij. The fund makes sure to select managers that will not neutralise each other's strategies, and de Vrij says there are strong risk controls in place. "We clearly monitor whether a hedge is still in target, and we have all kinds of re-balancing strategies. We monitor what a risk of each managers is in terms of value at risk, but also the internal contribution to our risk," he says.
Whether ABP allocates more to currencies will depend on whether it can find good managers, and whether there are new opportunities in the market. "I think currency deserves a lot of attention, which often it doesn't get," he says.