Three-quarters of respondents to this month's Off The Record poll use currency management. Of these, 83.4% did so for currency exposure hedging, 8.3% for returns and 8.3% for both reasons.
The remaining 25% of respondents did not use currency management, and a UK fund explained its reason for this: "We used to have an alpha generating curr ency management allocation, but economic conditions were such that the managers only needed to be on the right side of three bets (dollar/euro, dollar/yen, euro/yen) to make money. We did not feel we wanted to be invested in markets where there was such limited diversification."
The vast majority of respondents (87.5%) felt that currency risk is unrewarded and hedging it can reduce volatility without damaging returns. A Dutch fund commented: "When there are no important reasons why a currency would change its level against other currencies, hedging [takes] away short-term volatility. At times when there is an important conviction about the developments, we might change the percentage of hedging."
One in five of respondents considered currency markets to be a good source of alpha. "[We] believe that there are opportunities to make money via currency due to the different requirements from market participants," said a UK fund. A total of 25% either felt trading currency markets to just be gambling, or that foreign exchange is mean-reverting and therefore, over the long-term, hedging it is ineffective.
Over 93% of respondents considered currency hedging and seeking returns through currency management to be completely separate decisions. "Currency hedging is a consequence of other decisions in portfolio allocation, a sort of residual. Seeking returns may be taking a more trading approach in the market, just like commodities," said a Danish fund. A UK fund added: "Hedging is risk management, making sure your cash-flows for benefit payments are protected. Seeking returns is not risk management".
Just 13.5% of respondents said they had changed the way they approach currency management in the past 12 months. A Swiss fund stated that this had been done to "to achieve 100% hedging for foreign currency bonds and listed real estate". A UK fund that had not made a change in approach said it was because it considered "hedging a proportion of the exposure [to be] the right process to manage overall risk when investing in non sterling assets".
Respondents were nearly evenly split as to whether currency hedging is best done at pension fund level, or by the individual asset managers the pension fund uses. Hedging at pension fund level was selected by 60%, and asset manager level by 40%.
Some 64% of respondents said they were hedging all asset classes with foreign currency exposure, 14.5% only fixed income and 7% only fixed income and equities. The remaining 14.5% were hedging other asset classes, such as property. Of those respondents using alpha overlay currency management, 60% said they used an in-house manager and 40% used an external manager.
The majority of respondents (60%) judged their pension fund's currency management programme to be successful, with 13.5% considering it unsuccessful and 26.5% viewing it as average. A UK fund that felt its programme was average commented: "[The] hedging programme has been fulfilled without operational or counterparty losses, meeting client requirements. Tactical asset allocation has added value, but does not focus primarily on currency." A Danish fund that found it unsuccessful said: "[It is] not systematic enough [and] needs to adjust [its] goals and methods."