On the Record: Passive plays
What is your currency strategy?
Head of hedge funds & commodities, deputy head of alternatives
• Invested assets: €62bn
• Members: 1.61m active and 330,000 pensioners
• Hybrid: DC with guaranteed minimum interest return
After six years, we abandoned our active currency strategy in January.
We started this strategy as part of our alternative investment portfolio in 2006 with five different managers. The managers also had different approaches and styles including momentum, trend, carry and fundamental models.
For a while the trend and carry styles worked well but overall, apart from a positive return in 2008, the performance of these strategies was disappointing. Last year was a particular bad year for these approaches, including fundamental styles.
Nevertheless, we still believe that currencies, due to their low or even negative correlation with traditional asset classes, can make a good contribution and have a diversifying effect on the overall portfolio.
And we continue to run active currency strategies via our funds of hedge funds.
The problem is that since 2008 the investment models of the currency manager have no longer worked due to political distortions and interventions by central banks, which have often led to the destruction of currency trends. And it is difficult to foresee when these interventions and uncertainties will come to an end.
The so-called currency wars that are taking place at the moment are another reason why the traditional currency strategies no longer work.
The low volatility and narrow trading ranges in currencies did not help matters either. In the past, the proceeds of the collateral that currency managers had to deposit received interest of 3-5%; this has now fallen to almost zero. This lack of yield from the collateral also makes active currency strategies less attractive to us.
Therefore, we have decided to pull the plug on active currency strategies and overlays for the foreseeable future.
But we passively hedge our exposure to the US dollar and British pound sterling in our equity as well as alternatives portfolio including hedge funds, private equity, infrastructure and timber.
We hedge between 95% and 105% of the individual asset class against the two currencies.
There is a deceptive calm in the market with regard to the euro crisis because the fundamental issues have not been resolved. For that reason, the euro still seems overly strong and it is not unlikely that it will weaken further.
Inger Huus Pedersen
Head of fixed income
• Total invested assets of the five individual pension funds PKA manages: DKK194bn (€26bn)
• Total number of members across the five pension funds: 255,000
• DC scheme – but with partly guaranteed pension
• Date established: 1954
In general, we hedge our exposure to currencies between 70% and 100%, leaving very little currency risk for the pension funds. All our investments are about producing the right risk-return reward, and the same also applies to currencies.
We have had our in-house currency hedge in place for the last decade.
We mainly hedge US dollar, pound sterling and Japanese yen against Danish krone.
We do not hedge the euro because of its stable exchange mechanism with the krone, the ERM II. There is nothing preventing us from hedging that rate but as our euro positions are relatively high, it would probably be too large a hedge.
Furthermore, the gains from such a hedge have not tempted us thus far.
We do not hedge emerging market currencies either, because that would be too expensive, given the rate in most emerging markets. In addition, an appreciating currency is part of the emerging market bet.
We do not think that currency moves are easy to predict, which is why we have never made any active calls on currency.
Instead, we prefer to use our risk budget elsewhere. However, we run some active long-short strategies with some managers on currency but this total return approach is different to making active currency bets. Our overall positions are automatically hedged and this hedge has smoothed out returns and made the investments less volatile to currency fluctuations.
The currency wars that are going on at the moment are interesting to watch because everyone seemingly wants lower currency rates. But I do not have a firm view on those.
However, if you try to improve your competitiveness with a lower exchange rate you must make sure to look at structural problems too because a lower currency rate is not a standalone solution.
If anything, hedging currencies has become easier recently.
Since the financial crisis the basis in the market between dollar and euro has dropped, which is good news for a euro-krone based investor like us. As markets are loosening up it has become cheaper to trade currencies, which is a positive development for any pension fund.
PNO Media Pensioenfonds
Bruno de Haas
Head of policy and research
• Invested assets: €4bn
• Members: 48,000
• Funding level: 95%
• Date established: 1947
As far as currencies in developed markets are concerned, our policy is to hedge 75% of our dollar exposure on equity and 100% of dollar exposure on bonds. We have had this level of hedge in place since the beginning of last year. Prior to that our equity hedge stood at 100%.
We reduced the hedge following some research we did on the effects of lower dollar hedging on the risk profile of equity portfolios and we concluded that we could reduce the dollar hedge without increasing the risk profile of the portfolio.
In addition, due to the stress in financial markets the implicit costs attached to this particular hedge were very high in 2011 and 2012, meaning that by reducing the hedge we would also reduce our costs without increasing volatility.
Another reason for the reduction of the dollar hedge is that over the past couple of years the dollar has become a safe-haven currency. In other words, when global equities perform badly the dollar rises, meaning investors partly have an automatic hedge against equity losses if the currency is unhedged. The safe-haven effect of the dollar is a result of the credit crisis, particularly the debt crisis in the euro-zone.
The currency wars taking place at the moment are a symptom of the fragility of the global economy, in particular the difficulties that several large countries and regions have to maintain a decent growth rate. In that sense, they are an indication for us that the credit crisis is still not over.
In addition to the dollar hedge, we have a 100% hedge on the British pound sterling, both on our equities and bond exposure, which has been stable.
In emerging markets we do not hedge any currencies at all. With regard to currencies, this is the only strategic policy – we do not implement any active deviations from that.
Currencies are very volatile and unpredictable and there is a significant model uncertainty. It is extremely difficult choosing the right model for valuing currency and we do not feel equipped to do that.
Due to the solvency requirements of the Dutch regulator, we currently have no plans to reduce our dollar hedge further. If we did reduce it, we would have to maintain higher solvency requirements as our funding ratio is below 100%. We cannot increase our risk profile. This would mean reducing, for example, our equity exposure, which we do not want to do at this moment.