EUROPE - Interest in currency overlay management is growing as pension funds seek to gain extra returns through investments with a low correlation with traditional asset allocation, industry figures have said.

Scott Arnott, senior portfolio manager within the Global Fixed Income and Currency team at Goldman Sachs Asset Management, told IPE there has been “a shift in behaviour” in the way institutional investors think about currency management.

Arnott explained currency overlay was traditionally associated with reducing or hedging existing currency exposures. But as pension funds start to consider alternative investment strategies, currency overlay is being more and more used to add value.

"Actively managing is a natural next step because currency is something which generally already exists in most portfolios," Arnott said, adding: "Interest in active currency management is definitely growing."

Switching to overlay strategies is an option open to pension funds of every size, he said, but stressed that a low correlation with the pension fund’s traditional assets was key to success.

Arnott explained currency markets are very liquid, with a daily trading volume of 1.9 trillion dollars (1.5 trillion euros) according to a recent Bank for International Settlements survey.

He explained that many of those who trade in this market do so mainly as a means of exchange. As a result, generating excess returns can be 'a secondary factor', creating a high level of inefficiency and therefore potential returns.

Inefficient markets can be difficult to predict, and skilled managers using their investment abilities can recognise trends within the markets and exploit them, he said.

A survey by Russell/Mellon reveals that 87% of fund managers who have sought to add value through currency overlay management have succeeded.

Lars Ericsson, head of marketing at Stockholm-based IPM, agreed with Arnott. He said European institutional investors were becoming ‘increasingly comfortable’ with the use of derivative instruments in actively managing their portfolios.

“Pure alpha-seeking return strategy still remains largely in the hands of specialised portfolio managers, while a composite approach to hedge and alpha seeking is more often employed by larger institutions,” he said.

Pension funds and institutional investors in the Netherlands, Scandinavia and in the UK, where the currency overlay market has significantly grown in the last two years, are leading the way in Europe, Arnott said.