In this month’s Off the Record we asked you about a subject close to many peoples’ hearts – ‘cash’ – or, more precisely, the way in which pension funds manage or are obliged to manage currency and risk within their portfolios.
Responses came out an even split between those of you whose assets are denominated in a Eurozone currency and those still managing predominantly ‘domestic’ securities.
Happily for Off the Record, the diversity of non-Eurozone currencies quoted ranged from sterling through the dollar, Danish krone, Swiss franc and on to the Russian rouble and others – suggesting interesting variations in the responses to come.
And this diversity shows itself all too clearly in the proportions of assets which funds invest outside their home countries (excluding those investing solely domestically), stretching from a minimal 0.1% – perhaps not too difficult to guess which country this fund came from… up to 30% – with the average figure representing 17.3%.
Asked for a geographical breakdown of their portfolios, pension funds respondents were shown to have, on average, 50% of their securities in the eurozone – again with a range from the miniscule (0.1%) to the majuscule (100%).
Altogether, the rest of Europe accounted for 19.7%, the US 13.9%, Japan 5% and others 21% – a note of explanation for the final figure would be the proportionately high number of Swiss replies this month!
Of course, some of the more grown-up funds are already ‘playing’ with their exposure, showing sliding scales of exposure to different regions. One fund says it can shift from a 70%+ eurozone exposure down to 40% depending on its market view, with an inverse 10.8%-25% range permitted in the US – perhaps not too difficult to guess the country of origin here either.
Significantly, however, in today’s environment of never ending discussion over prudent person investment principles et al, almost three quarters of funds (71%) are still subject to restrictions on how they can invest their assets.
Around a third of funds say the restrictions are legal, showing that the patriarchal arm of the state is still fairly tightly coiled around the shoulders of pension funds – believing its advice to be sound and reasonable – like all fathers.
Nevertheless 40% of schemes say they impose their own criteria on investment through policy guidelines set by boards and trustees, with an encouraging number setting themselves flexible asset allocation ranges.
Examples of some of the restrictions set legally include one fund with a 20% foreign currency maximum and a 40% eurozone ceiling. Another notes its restriction to at least 30% of exposure in the domestic market.
And a third of pension funds note that such imposed ‘guidelines’ do have a practical effect on the way they invest, although one flags up its possible benefit: “It’s a strategic target which is annually reviewed”.
Looking at the overall picture of currency exposure in portfolios over the last 12 months, the majority (57%) of schemes responded that they had seen a positive effect on their investments – although equally two fifths of replies say the effect has been either negative or neutral.
One fund seems unsure whether the currency exposure has been good or bad – answering yes to both the positive and negative columns, which is perhaps indicative of the number of schemes answering that they don’t have that kind of information. With the fluctuations in currency markets today – perhaps a rethink needed here?
Figures given for the positive or negative figures added to portfolios by currency exposure underscore the point – ranging as they do from a positive 3% to a 3% drop off with varying degrees in between.
It could be somewhat surprising then that only 28% of you hedge your currency exposures as a matter of investment policy.
A number of funds explain why they don’t: “Currency exposure is part of our diversification strategy,” says one scheme manager.
Another adds: “When we invest abroad we assume the currency risk.”
For others, hedging is the manager’s remit: “We have no set strategy. It’s up to the manager’s interpretation where they believe hedging can add value.”
In terms of the strategies for those that do, one fund says it has a 50% hedge on non US equities, while another says it hedges to a level of 8% against the dollar.
Overall though, only a handful of funds note they have specifically hired managers, which are allowed to hedge. Half of these say they are happy with the investment service provided.
Those actively arguing against hedging exposure provide some compelling reasons though: “Currency exposure is a zero sum game. It is more cost effective to be self insured in the long run,” says one. Another dismisses the short term with a terse: “We are long term investors!”
For one fund, however, there is a positive distrust of what managers say they can do with short-term exposure: “Our investment manager alleges he can play currencies – the trustees believe him – I don’t!” The spat with the investment manager continues when the same fund is asked whether it is happy with its hedging: “The investment manager is not as clever as he thinks he is!”
Figures become even thinner, when schemes are asked whether they possess a currency overlay programme. Only 14% reply in the affirmative with one fund saying this covers 13% of assets and another noting that its approach varies – suggesting there is sophistication out there.
The split is even as to whether this is carried out in-house or externally, with three being the highest number of managers employed for currency management.
Interestingly, no fund volunteers to mention the name of their overlay manager.
Notably perhaps, those funds using overlay managers to add higher returns to their portfolios outnumber their risk-conscious counterparts two to one.
For those in the overlay game, it has been a relatively long-term affair with respondents dating strategies to pre 1994 or for ‘several years’.
Unsurprising then that these funds are highly satisfied – on the whole – with their set-up, with one scheme unable to control its excitement having received both expected performances – “YES!” and expressing satisfaction with the service “YES!” – unfortunately no names though, so funds will have to seek their own advice here.
And it seems pension funds are unwilling or feel insufficiently qualified to offer advice on the topic with a number of schemes stating that they would not attempt to counsel peers on the introduction of such a strategy.
A couple of drawbacks are alluded to by funds using such a programme, however, with one noting that “reporting and performance measurement” can be a problem. Another seems to be touching wood with a “hopefully not” comment – suggesting results have still to be collated to prove the case either way. IPE