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Special Report

Impact investing


Passive versus active

Nestlé Pension Funds, Global
Jean-Pierre Steiner,
• Invested assets: around CHF22bn (€15bn)
• Participants worldwide: 130,000
• 80% DB schemes, 20% DC schemes
• When first Nestlé pension fund was
established: 1948

Nestlé pension policy views currency as an important asset class that needs to be managed in a disciplined manner.

Across our various pension funds, we undertake passive currency risk exposure management, as well as active, alpha-seeking currency management.
We look at the overall currency risk exposure and determine how much we can leave unhedged. This tends to be the illiquid emerging market currencies first.

Because we think currency exposure is only good to the point where the diversification benefits end, our hedging ratio has become higher over time and we now easily arrive at a hedging ratio of 80%-plus. But it varies depending on the currency of the liabilities in the different schemes and the final decision of the trustees. However, as the company bears the risk for the large majority of the schemes, it strongly recommends that its various local funds follow a pretty homogeneous approach.

We tend not to hedge according to asset classes but by considering the overall currency risk. However, sometimes bonds or hedge funds are hedged already but often they can't be in the base currency of every pension fund. We have a pooled fund in bonds used by a number of our pension funds;. This pooled fund is hedged into dollars. That means that the non-US-based pension funds have to hedge the dollar against their respective currency.

For us, currency hedging and alpha-generating strategies on currencies are disconnected and are undertaken by different managers, most often unconstrained as far as alpha generating managers are concerned.

The alpha-generating strategies are generally leveraged because they are mainly undertaken through forwards and sometimes options so their funded portion is small. The size of those strategies depends on the individual pension fund. It has gone up to 25% for some plans but others have less - around 5-10% - devoted to their alpha mandates on currencies.

The alpha-generating strategies have provided good results for our US plans, even in the recent past. However, over the last two to three years they have failed to pay off for other plans, such as the Swiss plan, mainly due to a different mix of managers, although the strategies worked well prior to that, also for those latter plans.

Over the last year, the trend for us has been a slight increase of the passive hedging of currency risk exposure because trustees viewed it more as an unrewarded risk and because currency volatility, in the current climate, could increase further.

Royal County of Berkshire
Pension Fund
Nick Greenwood
Pension fund manager
• Invested assets: £1.1bn (€1.2bn)
• Participants: 40,000
• Open DB scheme

We choose to invest in overseas assets to produce and capture their long-term local return. We are not investing to speculate on the currency - in other words, the currency decision is completely separate from the asset decision. Once you have made the asset decision it then becomes a no-brainer to adopt a default position of hedging the currency. However, we also acknowledge that currencies are an efficient market and therefore skilled managers should be able to generate a return from currency trading.

Our aim is to be as fully hedged as possible in overseas assets. We hedge across most asset classes with the exception of the more illiquid, such as private equity, global property and infrastructure where we might consider only to hedge on an opportunistic basis. But that is very much a policy under discussion at the moment.

We are currently in the middle of reorganising all our assets and adjusting the hedging mandates so that the manager of an asset class, for example global equities, has a 100% hedged benchmark. Hedging is his responsibility and is part of his mandate.

We still have a residual passive currency hedging overlay with a 50% hedge ratio, but that is being wound up and should be gone within six to nine months.

We also have a separate allocation - 5% of the fund - to three different active currency managers, which we appointed in April. They are not doing overlay so there are no equity derivatives in their mandates, they simply try to add value over cash.

Until January we had an active currency overlay manager but his performance was disappointing. We took the view though that it was just a bad experience.

Our approach is quite different from many other UK pension funds, which tend to have active currency management as an overlay against equity. In other words, the active currency fund they hold will typically have significant exposure to equities. Similarly, the passive currency hedging is done as an overlay by an independent manager rather than within the mandate as part of the benchmark for the manager.

Being hedged in overseas equities as a sterling investor was not conducive to good returns late last year when sterling declined rapidly.

Inger Huus Pedersen
Head of fixed income
• Total invested assets of the eight Danish pension funds PKA manages: DKK110bn (€14.8bn)
• Participants: 230,000
• Hybrid scheme based on DC but with a certain level of guarantees
• Date established: 1966

We do not have any specific concerns regarding currency management. All our investments are about producing the right risk-return reward, and the same also applies to currencies.

We have had a passive currency hedge in place over the last eight years. With that we have hedged away the risk in the major currencies such as the dollar, yen and sterling.

The Danish regulator allows pension funds to leave a substantial amount of euro - up to around 80% of their total assets - unhedged. This is because the Danish kroner is shadowing the euro in the European exchange rate mechanism, the ERM II. And that means that for regulatory reasons we do not have to hedge away the currency risk in euro, to which we have a large exposure through our investments.

We do not hedge only particular parts of the portfolio. As a rule we hedge everything, meaning every asset class that is not in Danish kroner or euros.

But because we hedge almost 100% of the portfolio, and it is undertaken in a passive manner in-house, we do not regard it as currency management. Instead we view it as a kind of insurance.

Apart from the hedging side, we are now also at the beginning of implementing an active, return-seeking strategy on currencies, which we hope to complete this year. It will take the form of a total-return approach and is a completely separate decision to the hedging business.

As a pension fund, we have started to look at total-return strategies over the past year because we believe these strategies contain some value for us. We have already implemented the total-return approach in some of our asset classes, such as commodities, and hope to be equally successful with this in the currency business.

But unlike our passive hedging strategy, the active currency management will be awarded to external managers because we do not have the expertise to do this in-house.

If we had not had the hedge in place over the last couple of years, we would have been worse off. In particular, the weakening dollar would have created a loss for us.

The hedge has smoothed out returns and made the investments less volatile to currency fluctuations - in other words, the pension fund has so far been benefiting from our approach to currency management.

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