More funds eyeing active currency hedging

Less predictable returns, volatility patterns prompt changes in strategy

James Wood-Collins
James Wood-Collins said increased awareness of the need for hedging follows the greater investment abroad by U.S. investors.

Institutional investor demand for dynamic currency hedging strategies is growing, and U.S. investors — perennial wallflowers at the global hedging ball — might finally be ready to join the party, money managers say.

In recent weeks, two big institutional investors — the $286.4 billion California Public Employees' Retirement System, Sacramento, and $7.1 billion AUSCOAL Super, Sydney — announced they would shift to dynamic hedging programs from passive ones. (All figures in this story are U.S. dollars.)

The ongoing “tapering” of the U.S. Federal Reserve's quantitative easing policy and diverging country growth profiles are making for less predictable return and volatility patterns across currencies, prompting a broad swath of institutional clients to review trend-following passive approaches. For the bulk of U.S. investors, by contrast, it's more a matter of rethinking their hands-off stance toward currency hedging.

For currency managers earning scant fees of as little as three basis points on the notional overseas exposure they hedge passively for clients, dynamic strategies — with fees in the low to midteens — are a higher-margin business.

CalPERS has yet to announce how it intends to implement its active hedging strategy.

AUSCOAL tapped State Street Global Advisors to hedge its $1.4 billion in overseas exposure, using the Boston-based firm's dynamic strategic hedging strategy.

That strategy, with $16.5 billion in client assets, has enjoyed the highest demand in recent years — from Australian, European and, increasingly, U.S. investors — among the range of offerings that comprise SSgA's $112 billion currency business, said Simon Sukhaseume, a Sydney-based senior portfolio manager and head of currency with SSgA, in an interview. Mr. Sukhaseume declined to name any new U.S. clients.

Other currency managers report the same trend.

“We've certainly seen growing interest in recent months in dynamic hedging strategies,” with much of that interest coming from U.S. investors, said James Wood-Collins, CEO of London-based currency manager Record PLC. Mr. Wood-Collins declined to name any U.S. clients.

More vulnerability

That interest reflects the dramatic rise in overseas allocations made by U.S. investors since the last big dollar rally between 1994 and 2001, Mr. Wood-Collins said. With more portfolios vulnerable now to a greater degree should the dollar strengthen, “there's much wider interest in hedging this time around,” he said.

A June survey of institutional investors worldwide by Natixis Global Asset Management showed only 9.5% of U.S. investors saying they hedge their currency exposures, compared to a range of between 72.5% and 85.7% for investors in Asia, the Middle East, the U.K., Europe and Latin America.

The dollar's rebound since July 2011 has left the median U.S. institutional investor with a 25% allocation to overseas equities suffering an annual hit of roughly one percentage point to total portfolio returns, said Ron Liesching, chairman of Bellevue, Wash.-based currency manager Mountain Pacific Group LLC.

In an interview, Adrian F. Lee, president and chief investment officer of London-based Adrian Lee & Partners, said there's been a noticeable pickup in interest from U.S. institutional investors in dynamic hedging since “tapering” became a policy buzzword in May, even if most of those investors remain in the “study” stage at the moment.

Managers say the current moment is one of flux when it comes to approaches to currency hedging.

“Since many (U.S.) investors are addressing this professionally for the first time, there doesn't yet seem to be a consensus as to the "best' approach,” as reflected by “the wide range of conversations we're having with U.S. investors about tailored currency management approaches,” Mr. Wood-Collins said.

But more conversations in the U.S., as well as other major markets, are tilting toward the dynamic side.

SSgA clients in Australia that employ passive hedging have been much more active recently in adjusting their hedge ratios, Mr. Sukhaseume said. The firm's dynamic strategic hedging strategy, which reviews its model on a monthly basis, is the next step on that spectrum, he said.

Rising profile

As a percentage of Record's total AUM, U.S. investors have jumped to 11%, or $5.7 billion, as of Dec. 31, 2013, from just 6%, or $2.5 billion, as of March 31, 2007, and while there hasn't been a flood of new mandates yet, Mr. Wood-Collins predicted the profile of U.S. investors is set to rise dramatically, both for Record and for the industry as a whole.

That $5.7 billion total doesn't include a $600 million mandate Record got at the start of 2014, Mr. Wood-Collins said. He declined to name the client.

Others say triggers already are being pulled with more frequency this year.

Australian clients have accounted for the bulk of SSgA's dynamic hedging AUM, with $10.7 billion of the strategy's $16.5 billion total, but a pickup this year in North American mandates — amid the prospect of U.S. Federal Reserve tightening that could buoy the U.S. dollar and lower the value of U.S. investors' overseas holdings — could help double the strategy's AUM by mid-2014, Mr. Sukhaseume said.

With the exception of AUSCOAL, he declined to name any of the strategy's other new clients.

It's too early to say currency hedging has graduated from “minor sport” to “mainstream” for the U.S. market, Mr. Wood-Collins said. When it does, “this will be the transformational strategic opportunity not just for Record, but for the entire currency management sector,” he said.

Reporters Barry B. Burr and James Comtois contributed to this story.

This article originally appeared in the March 17, 2014 print issue as, "More funds eyeing active currency hedging".