As investors worry over the fate of Europe’s economy and the effectiveness of the ECB’s quantitative easing programme, volatility in the currency markets has intensified. We ask three European investors - a Danish, a Dutch and a Swiss pension fund - how they deal with currency risk management
PKA Denmark: Søren Grooss, Portfolio manager
• Location: Hellerup
• Assets: DKK200bn (€27bn)
• Membership: 265,000
• Administrator for healthcare sector pension funds
“We have quite tough restrictions on what level of currency exposure we can run. Within our absolute return portfolio, we have a risk budget allocation for foreign exchange. As for the currency exposure that is inherent in our assets, we have a strategic hedge on most of our currency risk.
We also do specific trades in FX risk premia that are coherent with our overall asset allocation.
However, with regard to the exposure to the euro we can be partly hedged or unhedged as legislation is less strict than for other currencies. We have not taken any specific precautions for the current situation, as we consider the Danish krone fairly valued towards the euro.
As far as our reaction to the European Central Bank’s announcement on quantitative easing and the resulting general weakness in the euro, we must highlight that at PKA we do things differently from most funds.
We build our portfolio by getting exposed to alternative betas. We truly believe that is the best way to build a robust and diversified portfolio. Therefore, we rarely worry about or express judgments on directionality.
In particular, we are not directional on macro events, because we do not feel we have the predictive power to consistently create returns by trying to beat the market around those events.
We try to diversify the portfolio every day, not around single events.
We follow a comprehensive risk-premium approach, which seeks to transfer our inherent equity risk to sources of alternative risks that are uncorrelated to the equity markets.
We are committed to constructing our portfolio in a way that makes it resilient to different events, rather than hedging on taking bets on single macro events.
We believe the portfolio we have constructed, by allocating away from equity risk and by diversifying overall risk, actually provides a hedge even in the event of a risk-off scenario. On the other hand, we feel confident that our portfolio would benefit a bull market, if that were the effect of the QE announcement.
We are trying to focus on the overall portfolio composition, so that it can handle potential macro shocks, rather than trying to manage single day events.”
PME Netherlands: Marcel Andringa, Executive director, asset management
• Location: Schipol
• Assets: €39.5bn
• Membership: 150,000
• Industry-wide fund for employees of the metal industry
“PME has adopted a currency strategy that consists of hedging all the risk exposure to developed market currencies, save for the US dollar. We only hedge 75% of our exposure to the US dollar, and that decision is derived from the ALM studies we have conducted, which suggested that was the optimal hedging level.
The currency positions in the Japanese yen and the UK pound are hedged 100% using derivatives.
The other currency exposures, which are relative to part of our sovereign fixed-income positions, are not hedged. However, within the constraints of their mandates, appointed investment managers may adopt currency risk-hedging strategies.
In 2011, PME made a strategic decision to diversify the government bond portfolio. Thus, we acquired bonds of creditworthy non-euro countries, gaining exposure to the Australian dollar, the Canadian dollar, the Danish krone, the Norwegian krone, the Singapore dollar and Swedish krona. These currency positions are not yet covered, since the size is relatively small.
We did not change our hedging policy in response to the weakening of the euro after the European Central Bank loosened its monetary policy. The currency-hedging policy is strategic, so we have no plans change it soon.
At the same time, we have not made changes to our portfolio exposure in response to the recent movements in the currency markets, and we are not considering any such changes.
PME does not do any tactical allocation, therefore there were no tactical reactions to the ECB’s announcement on QE and the subsequent weakening of the euro.
The impact of our currency-hedging policy on returns last year was positive. The return in 2014 was 17.8%, helped by an 11.5% return on equity and a 12.9% return on fixed income.
With respect to the volatility and weakness of the euro, we believe the impact on our portfolio and on the value of our liabilities will be minimal. Our liabilities are affected by the persistently low interest rates, having increased 20% during 2014 because of falling interest rates. That, in turns, affects our funding levels.
On the other hand, our hope is that a weaker euro will support the recovery of Europe’s economy.”
Pensionkasse SBB, Switzerland: Markus Hübscher, CEO
• Location: Bern
• Invested assets: CHF16bn (€15bn)
• Membership: 55,000
• Pension fund for employees of the Swiss railway system
“We look at our currency exposure from a risk perspective and apply a currency risk overlay strategy. Around two-thirds of our currency exposure is hedged. We did not change our currency risk strategy or the asset allocation of our portfolio as a result of the Swiss National Bank’s decision to break the link with the euro. We do not make short-term tactical decisions, as we do not believe they add enough value. We stick to our strategic plan and hedge part of our currency risk.
The Swiss franc has always been a strong currency. Therefore, currency hedging a significant part of foreign investments was always a good idea, and this did not change after the SNB’s decision. We have to be mindful of the fact that our domestic currency probably will remain strong in the medium term.
Historically, thanks to differences in underlying interest rates, the imbalances between economies have been smoothed. This mechanism has somewhat relieved pressure on currencies, thus limiting excessive depreciation or appreciation.
Today, with most interest rates tending towards zero, all the imbalances are translated into exchange rate differentials. The resulting pressure on exchange pressure is particularly hard for currencies such as the Swiss franc, which traditionally is a strong one. And therefore it is particularly hard for our export industry, which will suffer the most from the strong pressure on the Swiss franc.
Our exposure to the domestic equity markets is about a third of our overall equity exposure. From an MSCI-World perspective, we have a domestic home bias. So far, as part of our regular reviews of the portfolio, we have not recorded any clear signals suggesting that we need to reduce our domestic equity exposure.
For Switzerland, we expect headline inflation to drop and enter negative territory and, as a result, growth rates to go down. Our return expectations for 2015 are also lower.
But the main question for us is, what are the long-term implications of the current negative-interest-rate environment for the whole fund? Although our long-term return expectations have come down, we are not in a position to increase our investments in risky assets, as we have an allocated risk budget. We have been trying to squeeze out more return from our fixed-income portfolio by increasing risk, although we had to reduce risk elsewhere.”
Interviews conducted by Carlo Svaluto Moreolo